Interest rate swaps are financial agreements between two parties to
exchange interest rate cash flows over a set period of time. The two
parties agree to exchange interest rates, typically one with a fixed
interest rate. This is a way for a bank to offer a long-term fixed rate in
any interest environment while maintaining a competitive edge with
larger banks. Interest rate swap loans allow the borrower to pay a
variable rate on the loan, often using The Wall Street Journal prime
rate. Under the swap agreement, a borrower receives the same rate
that is paid to the bank and pays a fixed interest rate per the terms
of the swap agreement.
If the rate on the replacement swap is higher when the borrower
prepays, the borrower will receive a payment from the bank.
Equally, if the replacement rate is lower when the customer prepays,
the customer will make a payment to the bank. If a swap is held to
maturity, then no “breakage” is owed by either party.
There are some situations where an interest rate swap can be
valuable. When financing construction and development projects,
the bank will commit to provide a permanent mortgage. This is
typically offered after a 12- or 24- month interest only period during
the construction phase. Using an interest rate swap will allow the
borrower to fix the interest rate for the permanent mortgage up to
12- or 24-months in advance. This can be extremely valuable in an
increasing rate environment but, more importantly, this effectively
removes the interest rate risk from the permanent mortgage.
However, interest rate swaps are not appropriate for all situations.
If the borrower expects to accelerate the repayment of the loan or if
the borrower anticipates selling the property in the near term, they
might want to consider alternative pricing strategies. The best way
to determine if an interest rate swap is a good solution for you is to
speak with your lender. Your lender will be able to determine if you
qualify as a swap contract participant and will determine the best
structure for your loan.
According to the CME Fed Watch Tool, there is a 40% probability of a
late cut in May and 60% probability that interest rates will remain flat
at their current range. These numbers are significantly different from
the January predictions. This demonstrates the volatility of interest
rate markets and the benefit that interest rate swap can provide.
CNB partners with B&F Capital Markets to provide our borrowers with
an interest rate swap. This partnership with B&F allows us to initiate,
develop, and grow successful interest rate product programs for the
benefit of our commercial loan clients. However, it is imperative that
the borrower has a full understanding of the loan and that all their
questions or concerns are addressed before proceeding.
If you are interested in learning more about interest rate swap loans,
contact us today at (585) 419-0670.
This material provided by Paolo Gatto