What it is:
A back-to-back commitment is an agreement to buy a construction loan on a future date or make a second loan on a future date.
How it works/Example:
For example, let’s assume that Company XYZ applies for a construction loan from Bank ABC. Company XYZ intends to use the money to build a new restaurant. Bank ABC makes the loan, but it does so with a back-to-back commitment; that is, Bank DEF agrees to purchase the loan from Bank ABC in two years.
Alternatively, Bank ABC could make a back-to-back commitment by agreeing to make the construction loan to Company XYZ, but also agreeing to replace that construction loan with a once the construction is finished in a year and Company XYZ satisfies certain terms of the construction loan.
Why it matters:
The idea behind a back-to-back commitment is to reduce lenders’ risk. One way a lender can do this is by lending money knowing that it is only “on the hook” until a predetermined second lender comes in later and buys the loan. Another way a lender reduces its risk with back-to-back commitments is by replacing construction loans with loans that provide the lender with better access to collateral (the completed construction) or more friendly terms. It is important to remember, however, that back-to-back commitments typically apply only to construction loans.