What Is a Loan Covenant? | Business Lending Glossary
Learn what loan covenants are, the difference between affirmative and negative covenants, and what happens when a borrower is in breach.
Definition
A condition or restriction written into a loan agreement that the borrower must comply with throughout the life of the loan.
Explanation
Covenants are broadly divided into affirmative covenants (things the borrower must do, such as maintain insurance or submit financial statements) and negative covenants (things the borrower must not do, such as taking on additional debt above a threshold). A covenant violation, known as a breach, gives the lender the right to accelerate repayment or impose penalties.
Example
A term loan agreement includes a financial covenant requiring the borrower to maintain a debt service coverage ratio of at least 1.25x; falling below that ratio triggers a lender review.
Why It Matters
Understanding every covenant before signing is critical — even technical breaches can give lenders the right to call a loan, so borrowers must model their financials against all thresholds.
Frequently asked questions
What happens if I breach a covenant?
A breach typically triggers a lender notice period during which you can cure the violation; if uncured, the lender may accelerate the loan balance or impose a default interest rate.
