Definition
Standby Commitment refers to an arrangement between a lender and a borrower where the lender agrees to make a specified sum of money available to the borrower at predetermined terms for a specified period. The borrower pays a standby fee for this commitment and retains the option of closing the loan within the stipulated time frame or allowing the commitment to lapse. This financial instrument provides flexibility and guarantees financing under agreed conditions, making it a valuable tool in real estate transactions.
Examples
Real Estate Development
A real estate developer might secure a standby commitment from a bank ensuring that funds are available for a new construction project. The developer pays a standby fee to keep this option open in case the primary financing falls through.
Corporate Expansion
A corporation planning to expand might obtain a standby commitment to ensure that financing is available when needed. This allows the corporation to move forward with its expansion plans with the certainty that it can access funds, if necessary.
Property Purchase
An individual planning to purchase a property might acquire a standby commitment to ensure they have the funds available at competitive rates. They would pay a standby fee to secure this financial backing, providing assurance and flexibility in their purchasing decision.
FAQs
What is a Standby Commitment in Real Estate?
A Standby Commitment in real estate is an agreement by a lender to provide funding under specified terms if the borrower chooses to avail it within an agreed timeframe, in exchange for a standby fee.
What is a Standby Fee?
A standby fee is the charge paid by the borrower to the lender for holding the commitment open and making the funds available upon the borrower’s request.
Why would a borrower opt for a Standby Commitment?
Borrowers use standby commitments to guarantee access to funding, providing financial security and flexibility for future plans, such as real estate purchases, developments, or corporate expansions.
Can the borrower choose not to use the Standby Commitment?
Yes, the borrower retains the option to either close the loan within the agreed timeframe or allow the commitment to lapse if they find alternative funding or if the need for funds diminishes.
How is the Standby Fee calculated?
The standby fee is typically a percentage of the total commitment amount and can vary based on the terms agreed upon between the lender and the borrower.
- Commitment Fee: A fee paid to a lender by a borrower for agreeing to a line of credit or loan that the borrower may not draw upon immediately.
- Line of Credit: A credit facility extended by a bank or financial institution that allows the borrower to draw on the maximum loan amount as needed.
- Option to Purchase: A contractual right allowing a buyer to purchase a property within a specific timeframe at predetermined terms.
Online Resources
References
- “Real Estate Financing” by Peter Linneman.
- “The Handbook of Real Estate Portfolio Management” by Joseph L. Pagliari Jr.
- IRS Publication 946 - How To Depreciate Property
Suggested Books for Further Studies
- “Real Estate Finance and Investments” by William Brueggeman and Jeffrey Fisher
- “Lending and Borrowing in Real Estate Markets” by Richard B. Peiser and David Hamilton
- “Real Estate Investment: A Strategic Approach” by David M. Geltner and Norman G. Miller
Real Estate Basics: Standby Commitment Fundamentals Quiz
### What is a Standby Commitment?
- [ ] A full loan disbursement
- [ ] An agreement to buy property
- [x] An agreement to provide a sum of money under specified terms
- [ ] A property's sales contract
> **Explanation:** A Standby Commitment is an agreement between a lender and a borrower where the lender provides a sum of money under specified terms if needed by the borrower, often involving a standby fee.
### What does the borrower pay to keep the standby commitment active?
- [ ] Interest rate adjustment
- [x] Standby fee
- [ ] Principal repayment
- [ ] Title insurance
> **Explanation:** The borrower pays a standby fee to the lender to hold the commitment open and make the funds available upon request.
### Can a borrower decide not to use the funds from a Standby Commitment?
- [x] Yes, the borrower can let the commitment lapse
- [ ] No, they are obligated to use the funds
- [ ] Only if approved by the lender
- [ ] Only if another funding source is found
> **Explanation:** The borrower retains the option either to close the loan within the agreed timeframe or to allow the commitment to lapse if they find alternative funding or no longer need the funds.
### What might affect the calculation of a standby fee?
- [ ] The borrower's credit score
- [x] The total commitment amount
- [ ] The property's location
- [ ] The type of property involved
> **Explanation:** The standby fee is typically a percentage of the total commitment amount agreed between the lender and the borrower.
### Why might a real estate developer secure a standby commitment?
- [ ] To sell the property
- [x] To guarantee funds are available for a project
- [ ] To avoid taxes
- [ ] To transfer property title
> **Explanation:** A real estate developer might secure a standby commitment to ensure funds are available for a project, providing financial security and flexibility in case primary financing falls through.
### What is another term for a fee charged for a lender holding a commitment?
- [ ] Application fee
- [ ] Closing fee
- [x] Commitment fee
- [ ] Processing fee
> **Explanation:** A commitment fee, similar to a standby fee, is paid by the borrower to the lender for holding open a loan or line of credit commitment.
### What role does the lender play in a standby commitment?
- [x] Agrees to make funds available
- [ ] Manages property ownership
- [ ] Provides mortgage insurance
- [ ] Negotiates property pricing
> **Explanation:** In a standby commitment, the lender agrees to make funds available to the borrower under specified terms, providing a financial guarantee.
### Is the use of a standby commitment restricted to real estate?
- [ ] Yes, only for real estate purchases
- [x] No, it can be used for various financial needs
- [ ] Only for commercial property
- [ ] Only for residential property
> **Explanation:** Although commonly used in real estate, a standby commitment can be employed to secure funding for various financial needs, including business expansions or equipment purchases.
### Which of the following typically offers standby commitments?
- [ ] Real estate brokers
- [ ] Homeowners associations
- [x] Banks and financial institutions
- [ ] Property managers
> **Explanation:** Banks and financial institutions typically offer standby commitments as part of their lending services to provide financial security and flexibility to borrowers.
### Which element is essential for qualifying a property under a standby commitment?
- [x] Terms and conditions specified in the agreement
- [ ] Application for property insurance
- [ ] Transfer of property ownership
- [ ] Monthly mortgage payments
> **Explanation:** The terms and conditions specified in the agreement between the lender and borrower are essential elements in qualifying a property or project for a standby commitment.
