Covenant DefaultCredit Repair Definition
Violation of a specific term or condition (covenant) in a loan agreement, other than failing to make payments.
Definition
A covenant default, also known as a technical default, occurs when a borrower violates a specific term, condition, or promise (a covenant) outlined in a loan agreement, even if they are still making their payments on time. Loan agreements often include various covenants designed to protect the lender's interests. These can be affirmative covenants (requiring the borrower to do something, like maintain certain financial ratios, provide regular financial statements, or keep property insured) or negative covenants (prohibiting the borrower from doing something, like taking on additional debt, selling major assets without permission, or changing business ownership). A covenant default can trigger penalties, increased interest rates, or even allow the lender to demand immediate repayment of the entire loan (acceleration), depending on the severity of the breach and the terms of the agreement.
Frequently Asked Questions
What are common examples of loan covenants?
Common covenants include: maintaining specific financial ratios (e.g., debt-to-equity ratio, current ratio), providing timely financial statements, maintaining insurance on collateral, restrictions on selling assets, limitations on additional borrowing, restrictions on dividend payments, and requirements to maintain business operations.
What happens if a borrower commits a covenant default?
The consequences depend on the loan agreement and the lender's discretion. The lender might: issue a warning, require the borrower to fix the breach (cure period), impose fees or higher interest rates, demand additional collateral, restrict further borrowing, or declare the entire loan immediately due and payable (acceleration).
Is a covenant default as serious as a payment default?
While payment defaults (missing payments) are often seen as more immediately critical, covenant defaults can also be very serious. They signal potential financial distress or increased risk for the lender, and can lead to significant consequences, including loan acceleration, even if payments are current.
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