Letter of Intent in Loans: Everything You Need to Know

When applying for a loan, especially a high-value one such as a business loan or mortgage, a Letter of Intent (LOI) plays a crucial role. It acts as a preliminary agreement that outlines the key terms and conditions before finalizing a formal loan contract. While an LOI is not legally binding, it sets clear expectations between the borrower and the lender.

In this blog, we will explore the meaning, importance, and key elements of an LOI in loans, along with frequently asked questions to clarify common doubts.

What is a Letter of Intent (LOI) in Loans?

A Letter of Intent (LOI) in loans is a document that outlines the preliminary agreement between a borrower and a lender before the final loan approval. It serves as a formal statement of interest, specifying key terms such as loan amount, repayment tenure, interest rate, and any special conditions attached to the loan.

Key Features of an LOI in Loans:

• Expresses the borrower's intent to take the loan.
• Specifies initial loan terms and conditions.
• Provides clarity before the final agreement is signed.
• Acts as a guide for further negotiations.

LOI Usage in the Banking Sector

LOIs are commonly used in the banking and financial services sector for various purposes:

1. Loan Agreements

Banks issue LOIs to prospective borrowers outlining proposed credit terms before finalizing the personal loan contract. It sets expectations for key factors like loan amount, interest rate, fees, and collateral.

For instance, IDFC FIRST Bank issues LOIs to clients specifying indicative terms subject to due diligence, as a precursor to sanctioning loans.

2. Mergers and Acquisitions

During mergers or acquisitions of banks, LOIs are signed indicating intent to acquire before the final binding agreements. It helps establish major deal terms upfront between the parties.

3. Loan Syndication

The lead bank uses an LOI to confirm key terms to fellow lenders in a syndicated loan. It acts as a prelude to the comprehensive facility agreement.

4. Loan Refinancing/Restructuring

Banks use LOIs to lay out proposed new terms when refinancing or restructuring existing loans of borrowers. This precedes the drafting of final binding legal agreements.

5. Loan Sales

Banks planning to sell a loan may issue an LOI to potential investors outlining the proposed terms of sale before final documentation.

6. Loan Participation

Lead banks send LOIs to participants specifying key information before they join the lending consortium.

7. Project Financing

LOIs may be issued specifying terms of financing for large infrastructure projects before the main set of project contracts are signed. Banks provide LOIs to show their commitment towards lending proposed amounts to borrowers under defined terms in the future.

Key Elements of a Banking LOI

While the letter of intent format and contents vary from case to case, LOIs in banking generally cover:

1. Parties Involved: Names and details of the bank and borrowing entity entering the agreement.
2. Nature of the Deal: A short description of the proposed deal – term loan, working capital loan, syndicated facility, etc.
3. Loan Amount: The principal amount to be financed by the bank through the loan facility.
4. Interest Rate: The applicable interest rate – whether fixed, floating, or hybrid.
5. Repayment Terms: Proposed repayment structure – tenure, installment schedule, etc.
6. Fees and Charges: Details of one-time and recurring fees linked to the loan.
7. Collateral Required: Broad indication of assets to be securitized against the bank loan.
8. Conditions Precedent: Key pre-disbursement conditions like submission of necessary documents.
9. Validity Period: Duration for which the LOI terms are valid before expiry.
10. Exclusivity Clause: Restriction from seeking alternate financing during the validity period.
11. Non-Binding Clause: Disclaimer stating LOI is not legally binding.
12. Signatories: Signatures and details of authorized representatives.

Challenges with Banking LOIs

While useful in loan negotiations, some limitations exist in using LOIs:

• Risk of including too much information that requires rework later.
• Lack of precision in drafting, which may lead to misunderstandings.
• Potential for misuse to only block or delay competitive financing.
• Perception as quasi-contract even though legally non-binding.
• Changes in circumstance make original terms difficult to adhere.

How to Draft an Effective Letter of Intent for a Loan?

1. Use a Formal Structure: Begin with a professional salutation and mention the purpose of the letter clearly.
2. Mention Key Terms Clearly: Avoid ambiguity by stating the loan amount, interest rate, and tenure explicitly.
3. Be Concise Yet Detailed: Ensure the letter covers all necessary points without unnecessary details.
4. Use Professional Language: Maintain a respectful and professional tone throughout the document.
5. Seek Legal Review: If needed, consult a financial expert or legal professional before submitting the LOI.