Loan Covenant: Requirements Borrowers Must Meet
Understand what loan covenants are, common types of covenants, and how to stay in compliance with your loan requirements.
What Is a Loan Covenant?
A loan covenant is a condition in a loan agreement that the borrower must comply with throughout the loan term. Covenants protect the lender by requiring the borrower to maintain certain financial standards or refrain from specific actions that could increase risk.
Violating a covenant—even if you are making payments on time—can trigger a default, allowing the lender to demand immediate repayment or take other action.
Types of Loan Covenants
Covenants fall into two main categories.
| Type | Description | Examples |
|---|---|---|
| Affirmative | Things you must do | Maintain insurance, provide financials |
| Negative | Things you cannot do | No additional debt, no asset sales |
| Financial | Ratios to maintain | DSCR, current ratio, net worth |
Common Financial Covenants
Financial covenants require maintaining specific ratios or metrics.
- Debt Service Coverage Ratio (DSCR) minimum (often 1.20-1.25)
- Maximum debt-to-equity ratio
- Minimum current ratio (current assets vs. current liabilities)
- Minimum tangible net worth
- Maximum capital expenditures
- Minimum cash or liquidity requirements
Dealing with Covenant Violations
If you anticipate or experience a covenant violation, take action quickly.
- Notify your lender proactively before they discover it
- Explain the circumstances and your remediation plan
- Request a waiver for one-time situations
- Negotiate amended covenants if fundamentally unworkable
- Avoid actions that would trigger additional violations
Lenders appreciate proactive communication. If you anticipate missing a covenant, contact your lender immediately. They often prefer working out solutions over enforcing defaults.
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Read more →Important Disclosure
Not Financial Advice: The information provided in this article is for general informational purposes only and does not constitute financial, legal, or professional advice. You should consult with qualified professionals before making any financial decisions.
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