What Are Debt Covenants & How Do They Work?
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Debt Covenants, Defined
How Debt Covenants Work
What Is the Purpose of a Debt Covenant?
What Happens if a Debt Covenant Is Violated?
The borrower may be required to meet additional collateral requirements
The borrower could face a reduction in credit availability
The lender could subject the borrower to a higher interest rate
The lender could demand renegotiated loan terms less favorable to the borrower
The borrower could be forced to implement job cuts, including managerial turnover
The lender could liquidate the borrower’s assets
The lender could seize the borrower’s business and auction it to the highest bidder
Why Use Debt Covenants
Common Debt Covenants
1. Funded Debt-to-EBITDA Ratio
2. Interest Coverage Ratio
3. Fixed Charge Coverage Ratio
4. Limitations on Mergers and Consolidations
5. Debt Service Coverage Ratio
6. Miscellaneous Covenants
Positive and Negative Covenants
The Takeaway
About the Author
Sulaiman Abdur-Rahman writes about personal loans, auto loans, student loans, and other personal finance topics for Lantern. He’s the recipient of more than 10 journalism awards and currently serves as a New Jersey Society of Professional Journalists board member. An alumnus of the Philadelphia-based Temple University, Abdur-Rahman is a strong advocate of the First Amendment and freedom of speech.
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