A swap is a tool to turn a floating rate loan into a fixed rate. Typically, swaps are offered/mandatory on ~$3million plus loans. At some dollar level, a bank is only going to offer a fixed rate, if you would like to fix for a longer period of time, due to the risk the bank carries from interest rates rising. You might be able to fix a large loan for a shorter time period, perhaps three years, at some banks.
So, how does a swap work and can you be liable for something if you break the swap? Unfortunately, the answer may be yes. A swap is a completely separate agreement with a third party, where your bank simply acts as an intermediary. The swap is separate from the loan, and the bank is only offering you a separate product that allows you to “fix” your rate. Essentially you’ll pay a fixed amount and receive a floating rate in return, which offsets your floating rate on your loan. Let’s say for example, you have a $5mm term loan at 1 Month BSBY + 250 basis points. You would like to fix that loan for seven years, but your bank is only offering a swap. Depending on interest rates, your premium varies, but for our example, we’ll make it simple. You’ll be quoted an “all-in” rate, which is what you will pay each month. So, if 1 Month BSBY is 70 basis points, your all in rate might 4.85%. What is essentially happening , is that you’ll make your monthly bank payment and a monthly swap payment, and your overall, average interest rate will be 4.85%. The logic of a swap can be confusing, but essentially, your floating rate interest payments are netted out for a premium, and a small mark-up by the bank as an intermediary.
Should you swap your loan? That depends on where interest rates are headed as well as your tolerance for interest rate risk. You can always swap at any time or swap a lower dollar amount. MintFi stands ready to advise on any swap-related questions that you may have.