Although the definition of a leveraged loan tends to vary across the financial services industry, most definitions contain conditions for buyouts, acquisitions, and recapitalizations at the personal and corporate level. Most of the borrowers already carry a considerable amount of debt through other types of loans, so lenders offer leveraged loans with higher interest rates. Because there is a history of debt, these lenders consider leveraged loans high- risk, and the higher interest rates help to offset any future defaults by the borrowers.

How It Works

Because leverage loans are generally considered high- risk, most are funded from two separate agencies or lenders that take on the possibility of default by the borrower. For example, many leverage loans for personal homes and farms are co- sponsored by a bank and an affordable subsidized grant. When both of these agencies support the risky loan, neither will lose everything they have invested, and both can gain from a successful leveraged loan.

Leveraged loans are created through separate financial agreements between the applicant and each financial agency providing loaned funds. This sounds like extra paperwork, but most agencies work together frequently and can provide a streamlined process that avoids duplicated applications as much as possible.

Sources of Leveraged Funds

The main sources of half the leveraged loans are banks and other major financial institutions, but these agencies cannot offer leveraged loans on their own. The other funds must come from other agencies, and there are a variety of lenders that can offer the second piece of these loans. Market rate financing from a private lender is sometimes applicable in a leveraged loan, but there are always stipulations concerning the length of the term, balloon payments, and installments involved in these types.

Other subsidized financing is also available, such as grants with long- term restrictions. These constraints are applied due to the riskiness of leverage loans, but borrowers with reliable income should have nothing to worry with these loans. Options such as forgivable loans and deferred payment loans may be arranged for borrowers as provisions when loans are not properly repaid. Borrowers who wish to begin a leveraged loan for a house purchase may also be eligible for affordable housing loans offered by state and local government that can help provide the needed funding for the loan.

Leveraged loans are an opportunity for applicants who would not typically be eligible for bank- provided loans due to large debts to borrow the funds that they require to buy properties and businesses. Through a dual- lender system, leveraged loans allow high- risk applicants to receive the money that they need.