How it works
A term sheet is a proposal, not a commitment, and the distinction is material to a borrower relying on it to close a purchase. It is issued on preliminary information and remains subject to full underwriting, third-party reports, credit committee approval and satisfactory documentation. A borrower who has waived contingencies on the strength of a term sheet has taken the risk that the loan does not materialize.
The terms that determine the deal's economics are rarely the ones borrowers compare. Rate and proceeds are the headline, but the amortization period sets the payment and therefore the coverage; the recourse provisions determine personal exposure; the prepayment structure determines the cost of any future sale or refinance; and the reserve requirements determine how much cash is actually available to the owner each month. Two term sheets at the same rate can differ substantially on all four.
Conditions precedent are where a term sheet's true certainty lies. A term sheet subject to an appraisal supporting a stated value, a satisfactory environmental report, and a minimum debt yield at closing carries real execution risk. One issued after those items are substantially resolved carries much less. Reading the conditions is how a borrower judges whether a competitive rate is real.
Good practice is to negotiate the term sheet rather than accept it, because terms hard-coded at this stage are much harder to move once documentation begins. Amortization, the prepayment structure, the size of a guaranty and the burn-down conditions attaching to it are all ordinarily negotiable, and a borrower who raises them at loan documentation has lost most of the leverage they had at term sheet stage.
Common mistakes
- Treating a term sheet as a commitment
- It remains subject to full underwriting, third-party reports and credit approval. Waiving contract contingencies on it transfers that risk to the borrower.
- Comparing term sheets on rate alone
- Amortization, recourse, prepayment and reserves can matter more to the outcome than a difference of a few basis points.
- Not reading the conditions precedent
- They determine how much execution risk the quoted terms actually carry.
- Deferring negotiation to loan documentation
- Terms accepted at term sheet stage are treated as settled, and leverage to change them is largely gone.
Frequently asked questions
- Is a term sheet binding?
- Generally not as to the lender's obligation to lend. It is a proposal subject to full underwriting, third-party reports and credit committee approval, though specific provisions such as expense deposits or exclusivity may be binding.
- What should a commercial loan term sheet include?
- Loan amount, interest rate and whether it is fixed or floating, term, amortization period, recourse or guaranty provisions, prepayment structure, required reserves and escrows, fees, and the conditions precedent to closing.
- What is the difference between a term sheet and a commitment letter?
- A term sheet summarizes proposed terms before full underwriting and is generally non-binding. A commitment letter is issued after underwriting and credit approval and obligates the lender to fund, subject only to the stated conditions.