Back-to-Back Commitment - Explained
What is a Back-to-Back Commitment?
Written by J. Mance Gordon
Updated at April 18th, 2022
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Table of Contents
What is a Back-to-Back Commitment?How Does a Back-to-Back Commitment Work?Benefits of a Back-to-Back CommitmentWhat is a Back-to-Back Commitment?
A back-to-back commitment is an allegiance or dedication made by a bank or financial institution to make a second loan on a future date that is contingent upon the terms of the first loan being satisfied. A back-to-back commitment works based on a commitment that a second loan will serve as a piggyback to another loan, usually the first loan. Hence, once the obligations of the first loan are met, a commitment to make a second loan is made.
Back to:BANKING, LENDING, & CREDIT INDUSTRY
How Does a Back-to-Back Commitment Work?
This scenario will aid a better understanding of a back-to-back commitment. If the expenses for building a house is funded by a bank through a construction loan, a certificate of occupancy will be issued once the house is built, then the bank can make a new loan. The new loan is only made when all the terms of the construction loan are satisfied. Usually, the bank will roll out certain criteria that must be met before a commitment to fund the second loan can be made. An agreement to purchase a construction loan at a future or later date can also be referred to as back-to-back commitment. For instance, a bank can give a construction loan to build an apartment on the commitment that another bank will buy out the construction loan at a future time.
Benefits of a Back-to-Back Commitment
Lenders use back-to-back commitments to reduce the risks associated with issuing loans, these commitments are based on the idea that a bank offers a first loan depending on the dedication of agreement that a second bank will buy out the loan at a later time. In this type of agreement, the bank issuing the loan is only liable for the risk associated with the loan only for a short period before the bank buying out the loan takes on the liability at a future date. A construction loan can be rolled into a mortgage loan using back-to-back commitments. Lenders use this method to access tangible collateral that they can fall back on in case of default by the borrower. However, access to collateral is not instant, because these commitments are used in construction loans and collateral is only accessed on the construction is complete.