What Is a Back-to-Back Commitment?
A back-to-back commitment is a commitment to make a second take-out loan that piggybacks another loan. With a back-to-back commitment, once the terms of the first loan are satisfied, they will be rolled into the second loan.
- A back-to-back commitment is a commitment to make a second take-out loan on top of a first loan.
- A back-to-back loan mitigates risk for the lender by using terms of the first loan as collateral for the second one.
- Back-to-back commitment loans are common in the construction industry.
Understanding a Back-to-Back Commitment
The best example of a back-to-back commitment is when a bank makes a construction loan to build a house. Once the house is built and a certificate of occupancy is issued, the bank will make a new loan, probably a first mortgage loan, to take out the construction loan. The bank's commitment will specify the conditions that must be met in order for the commitment to fund the second loan to be valid. The term "back-to-back commitment" may also be used to describe an agreement to purchase a construction loan at a later date.
Benefits of a Back-to-Back Commitment
Back-to-back commitments help lenders to limit their risk. For example, if a bank issues a loan with the agreement that a second bank will buy it out at a later date, the originating bank mitigates risk by only being liable for a short period of the life of the loan. Liability passes to the bank buying out the loan after a predetermined period.
When a back-to-back commitment is used to roll a construction loan into a mortgage loan, the lender mitigates risk by gaining access to collateral to further secure the loan should the borrower default. A construction loan doesn't give the lender access to much collateral. However, if the loan is rolled into a mortgage loan once construction has been completed, the lender can use the new structure as collateral.
Example of a Back-to-Back Commitment
A borrower obtains a construction loan from Bank A to build a new restaurant. Bank A agrees to the loan on the condition that a back-to-back commitment is made with Bank B, with Bank B agreeing to buy out the construction loan in a year's time.