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