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A Complete Beginner’s Guide to Leveraged Loans

A Complete Beginner’s Guide to Leveraged Loans

When you enter the world of banking and finance you will quickly encounter a level of jargon and terms that you might struggle to understand in the first instance.

The basics of leveraged loans are actually not that difficult to grasp once you have fundamentals explained and this is a form of finance available to businesses and individuals.

Here is a look at what you need to know when it comes to this type of finance.

The basics

A leveraged loan is a term used to describe a type of finance that is offered to an individual or business who already has a high level of borrowing or a credit history that is less than perfect.

The general view of leveraged loans is that they can carry a higher level of risk to the lender because of the financial circumstances of the borrower and their previous payment performance.

The rate of interest charge for a leveraged loan is often reflective of the perceived level of risk.

Why consider a leveraged loan?

If you are a business and need to restructure the finances of the company or recapitalize the balance sheet, for instance, you might look to use a leveraged loan to achieve those aims.

Using a leveraged loan will give you a potential opportunity to restructure your finances or borrow cash that you need to resolve a situation or take advantage of a situation that could justify borrowing the money.

You can expect to pay a higher rate of interest with a typical leveraged loan. This is as a result of the potential risk of default based on either your high level of borrowings or poor credit history.

Who will lend?

Mainstream banks tend to lend most of their cash to what could be classed as investment-grade companies and they are often taken out of their comfort zone when presented with a loan proposal that is more speculative.

As a result of the high-risk nature of leveraged loans, it is commonplace to find that loans are syndicated to institutional investors, which means that the likes of mutual funds, insurance companies, and even hedge funds, could end up providing the finance when a bank won’t take that level of risk.

An investment opportunity

The other side of the coin is the scenario where you are looking to invest in leveraged loans rather than being the recipient.

An attractive feature of leveraged loans if you are an investor is the fact that the way they are structured means they can offer a level of protection against rising interest rates.

They can often be structured with a floating rather than a fixed rate and, therefore, the interest rate charge can rise in line with any adjustment to the base rates.

There are obvious risks attached to leveraged loans if you are in investor but the interest rate you will earn is reflective of that risk and the potential gains tend to offer adequate compensation in the eyes of investors who are looking for higher than average returns.

Now that you have a good grounding in the basics of leveraged loan you can look to take advantage of this form of borrowing either to restructure your debt or as an investment opportunity.

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