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 are used to mitigate risk on the part of the lender. For example, if a bank loans money with the agreement that a second bank will buy out that loan at a later date, then the bank issuing the loan mitigates risk by only being liable for a short period of the life of the loan; the liability will pass to the bank buying out the loan after a predetermined period.
In cases where a back-to-back commitment is used to roll a construction loan into a mortgage loan, the lender is mitigating risk by gaining access to collateral that can be used to recover losses in the event that the borrower defaults. A construction loan doesn't give the lender much access to collateral, but rolling that loan into a mortgage loan once construction has been completed and certain conditions are met allows the lender access to the new structure as collateral if the borrower defaults. However, because they are used to mitigate risk in cases where lenders don't have ready access to collateral, back-to-back commitments are usually only used in construction loans. Since the savings and loan crisis, the regulatory framework that allows for their use remains in place.
Example of a Back-to-Back Commitment
For example, a borrower takes out a construction loan from Bank A in order to fund the construction of a new restaurant. Bank A agrees to fund the loan on the condition that a back-to-back commitment is made with Bank B, such that Bank B agrees to buy out the construction loan in a year's time.