What is a Mortgage Commitment Letter?
A Mortgage Commitment Letter is a letter from a bank that says you have been approved to borrow money from them. In other words, it is a commitment from the bank, to the borrower, for the funds requested. Unfortunately, it is not that simple, and we will explore the fine print that accompanies all these letters today.
This should not be confused with a pre-approval letter, or a pre-qualification letter. These letters, while important when purchasing a house, are issued BEFORE you actually go to underwriting (underwriting is the loan department that approves your borrowing based on the home or asset you are purchasing.) Commitment letters are issued (typically) AFTER the loan has been through underwriting.
If you think about it in stages, this is typically how it goes:
1) Pre-approval or Pre-qualification (Pre-qual) Letter
Buyer calls bank, has credit check, gives some income information, than then gets a Letter saying they can purchase a home.
2) Preparing Package for Underwriting
Once you find a home, the lender will ask you to sign LOTS of docs, and provide even more. Be prepared, it's a lot! And most people find no Joy in it.
3) Loan Package goes to Underwriting.
The underwriters are the mythical creatures who approve - or don't approve - your loan. Most of the time, thankfully, the pre-approval process and the approval process agree, but nothing is official until it's been through underwriting.
4) Conditional Commitment Letter
Almost all loans that are approved by underwriting are conditionally approved. More on that in a bit, but you need to take care of the conditions.
5) Clear to Close
Once the conditions are done, you are "clear to close" and that means you are all set on the mortgage end. However, your mortgage contingency clause only covers your until step 4, unless you are careful and extend.
What do I need to know about Mortgage Commitment Letters?
LOTS! First off, the name is REALLY misleading. We all know what a commitment is. A promise. A pledge. A firm handshake when the deal has been struck. Regrettably, your commitment letter is rarely a true commitment from the bank. It is instead, a CONDITIONAL commitment letter.
Uh-oh. Conditional? What are the conditions? These conditions are the subject of this post.
Some conditions are obvious, and make sense. A common one that I see is that there can't be "significant" changes in your credit profile between the day the letter is issued and the day that you purchase the house. An example is if you decide to declare bankruptcy the day before you purchase a home, that will impact
Understanding that you commitment letter
is conditional is a key concept.
your credit, and that will likely mean that your loan will not be granted. That is a clear-cut case, but it still applies if you go out and buy 10,000 dollars of furniture on credit, and that such a purchase impacts your credit score so significantly that you don't qualify for the loan any more. Be careful of any major purchases just before closing, especially if your credit is just on the edge of whatever loan program you qualify for.
There are all sorts of conditions. Such as:
1) Making sure you still have a job
2) Making sure the house appraises at purchase price
3) Additional paperwork required either for the lender,
4) Additional paperwork required for the servicer,
5) Additional paperwork or conditions required for a regulatory agency
6) Additional paperwork required for for the eventual securitization of your loan
7) I have even seen subject to underwriting!
And many, many others. I have seen conditional commitment letters that are 5 pages long!
Do I need to be concerned about the conditions on my loan
Most of the time, no, the items are routine. But you need to review them carefully, and discuss them with your lender (or me!) so that we can make sure that they are low risk, paperwork pushing items. As an example, not having the appraisal done is a large risk, and a condition that should be removed from the commitment letter if at all possible. (Not all banks issue multiple versions of commitment letters, and some do not close out conditions in a useful fashion). Some items you can't control, (like losing your job) and will stay on the letter. Ultimately, when we are comfortable with your loan status, you can proceed with ending (or not extending) the mortgage approval clause in your purchase contract. The whole point of this post is to point out that no matter how close we get, the banks promise to lend is a tentative one, subject to change, and you are relying on them to make good. There are no guarantees when it comes to lending in this environment.
For those who really want to know, I've provided detail on some of the groups involved, but if you're OK at this point, you can skip this section. (It's kinda boring unless you really want to understand more of how mortgages really work. It's nerdy.)
Who are the servicers of my loan?
The servicers are the organization that bills you for your loan and manages the payments. It may be your bank, but it may not be. It may be the bank that is "holding" your loan, or it may not be.
Who are the regulatory agencies involved in my loan?
If your loan is going to Fannie Mae or Freddie Mac (and 90%+ of all loans today are headed that way), than the federal government gets involved in your loan. There are dozens of agencies, a real alphabet soup, and it's confusing enough that I will list just some. The FHFA, FTC, the FED, IRS, and HUD are just a few. There are also state agencies that can get involved. I'm not sure it's possible to predict which ones will require paperwork on your loan, but you won't know until you get through underwriting for most of it.
Why will I need to do paperwork if my loan gets securitized?
Most loans today are turned into securities - big, bundles of hundreds or thousands of loans, for reasons that have to do with making the inherent risk of lending more predictable, and freeing up capital for banks to do more lending. The vast majority of loans are bundled this way, and although the details are not important, the people who buy and sell these securities today are demanding additional paperwork before they agree to buy the security. Thus, more conditions for your loan, and more paperwork for you.