What Is a Make Whole Agreement

A make-whole agreement, also called a call premium or prepayment premium, is an agreement between a borrower and a lender that ensures the lender receives the full interest income it would have earned if the borrower had not prepaid the loan.

This agreement is commonly used in bond issuances and corporate lending. The borrower agrees to pay the lender a specified amount of money, usually a percentage of the principal amount, in the event the borrower decides to pay off the loan before the maturity date.

The make-whole amount is calculated using a formula that takes into account the remaining interest payments that the lender would have received had the borrower continued to make payments until the maturity date, as well as the cost of re-lending the money at current market rates.

Make-whole agreements serve as a form of protection for lenders against the risk of borrowers refinancing their loans at lower interest rates. This is particularly relevant in times of falling interest rates when borrowers have an incentive to refinance their loans. Make-whole agreements give lenders some degree of certainty that they will receive the full value of their loan, regardless of whether the borrower prepays.

Make-whole agreements are also a way for borrowers to secure lower interest rates on their loans. By agreeing to pay a make-whole amount in the event of prepayment, borrowers can negotiate lower interest rates with lenders. This is because lenders are willing to offer lower rates if they are compensated for the potential loss of interest income.

In conclusion, a make-whole agreement is an important tool used in lending agreements to protect the interests of both borrowers and lenders. It ensures that lenders receive their full interest income if the borrower decides to prepay the loan, while also allowing borrowers to secure lower interest rates on their loans.

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