With the prevalence of fix and flips and BRRRR-model investments steadily rising throughout the 21st century, the business of real estate investing has become increasingly accessible to small businesses/investor groups. This boom in smaller-scale real estate investments has been bolstered by modifications to the way in which non-bank lenders deal with prospective borrowers. In the midst of this boom there have been recurring misunderstandings about terminology which is key to the lending process, one of the most vital misunderstandings comes between a term sheet and a commitment letter. Despite these documents serving a similar purpose, the differences between them are important to understand.
The Difference is Important
A term sheet is an institutional expression of a lending establishment’s interest in providing financing for a transaction. While expressing explicit interest in fulfilling a loan, a term sheet is not a commitment to lend. As with many other contract explorations, a term sheet serves as a formal statement of good faith and intention to begin more concrete terms surrounding a loan. Every lending institution will have a different set of criteria outlined by their respective term sheet, but most term sheets will include:
- Borrower Name: The legal name of the borrower or borrowing entity; in many commercial real estate transactions, the borrowing body is a single-purpose entity specific to the deal at hand, making it important to explicitly document.
- Loan Amount: Subject to change, the stated loan amount on a term sheet is likely to change upon appraisal or third-party valuation of the property in consideration. The term sheet’s loan amount is detailed only by the knowledge which the lender has at the time of the term sheet’s release.
- Loan Purpose: A lending institution must directly outline the purpose for a loan, for example: “for the acquisition and development of a single family home”.
- Interest Rate: An estimation of the rate at which lender would consider extending a line of credit.
- Term Length/Maturity: The anticipated length of the repayment period on the prospective loan.
- Monthly Payment: The month rate at which the loan would be repaid over the anticipated term period.
- Collateral: In commercial real estate transactions, lending bodies will often require either the property in consideration or other properties be leveraged against the worth of the loan as security.
- Closing Requirements: The term sheet provides a first look at what requirements or items the loan recipient must have prepared before the loan will be paid out. Most often, closing documents are considered to be made up of confidential information and must be treated as such by the lending body.
- Closing Date: If all terms and conditions are met within the agreed upon time frame, the loan will be awarded by the “closing date” provided on the term sheet.
And if applicable:
- Guarantor(s): The term sheet provides the first opportunity for a lending body to require an additional sponsor on top of collateral or other financial backing.
- Performance Covenants: A covenant is a promise made by the borrower to the lender. Typically these covenants are placed on items like minimum liquidity or minimum insurance policies.
By contrast, a commitment letter is a formal commitment to lend. As opposed to a term sheet, a commitment letter is a legally binding agreement for the issuance of a term loan, as agreed upon by both parties. They are issued towards the end of the loan’s development cycle; only after a full underwriting and approval process. In order to be qualified as a commitment letter, the document must:
- Be in Writing: For the protection of both the borrower and the lending institution, a commitment letter must be written. This is to avoid miscommunications and make explicit the understood terms of the agreement.
- Include Basic Terms: “Basic Terms” refers to many of the same pieces of information included in the term sheet. These terms include loan amount, issuance date, interest rate, repayment structure, loan term, and more. The basic terms included in the commitment letter make official the discussed terms in the term sheet.
- Provide Disclaimers and Legal Jargon: Similar to the requirement to be in writing, a commitment letter must contain all appropriate legal language in order to best protect both borrower and lending body, as well as all guarantors and collateral.
A commitment letter, to be officially instituted over a loan package, must be signed by both the lender and the borrower. This letter is used as the official terms and conditions sheet for a loan and can be utilized by the borrower as proof of funding for investors and sellers, helping to prove the borrower’s ability to close on a transaction.
In short, the key difference between a term sheet and a commitment letter is that the latter is a legally binding and enforceable contract, while a term sheet provides only a formal framework of how a loan package may be worked out between parties.
If you’re looking for a non-bank lender for your investment clients, look no further than the experts at EMCAP Lending. Our experienced team is ready and waiting to help real estate investors of all scales to meet their financial needs for a wide variety of commercial real estate opportunities. EMCAP typically does not provide term sheets. We’re happy to review our proposed terms, but we’d prefer to cut to the chase, underwrite the Loan, approve it, and give you a commitment letter in the same time it might take another lender to give you a term sheet that holds no value.
For more information about EMCAP and how we can help you, contact us today.