The standard break costs clause, worked on a mid-period prepayment of a EURIBOR loan: the formula, the zero floor, the margin trap, and why waiting for the period end usually costs more.
Break costs are the interest the lender would have earned on the prepaid amount, at the rate fixed for the current interest period and excluding the margin, for the rest of that period, less what it can earn by redepositing the money until the period ends. Prepay €50,000,000 forty days into a 91-day period fixed at 3.10 per cent EURIBOR, with redeposit rates at 2.65 per cent, and break costs are €31,875: 0.45 per cent for 51 days. Read the definition first, because a version that includes the margin charges €315,208 for the same prepayment.
Worked in full in How to Read a Credit Agreement by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Break costs exist because a term-rate loan is funded, at least notionally, for each interest period. Repay part of it mid-period and the lender holds cash it fixed for a period at a rate the market may no longer pay. The clause compensates that one mismatch, and nothing else: it is not a prepayment premium, and it is not a loss-of-margin payment unless the drafting makes it one.
| Input | Value |
|---|---|
| Term facility | €300,000,000 |
| Amount prepaid, from asset sale proceeds | €50,000,000 |
| EURIBOR fixed for the current interest period | 3.10% |
| Margin | 4.00% |
| Interest period | 91 days |
| Prepayment made on day | 40 |
| Redeposit rate for the remaining 51 days | 2.65% |
| Day count | actual/360 |
The usual drafting, modelled on the Loan Market Association form, defines break costs as the amount, if any, by which (a) the interest excluding the margin the lender should have received from the prepayment date to the last day of the current interest period exceeds (b) what it could obtain by placing the same amount on deposit with a leading bank for that remaining period.
(a) Interest foregone = 50,000,000 × 3.10% × 51 / 360 = 219,583
(b) Redeposit income = 50,000,000 × 2.65% × 51 / 360 = 187,708
Break costs = MAX(0, (a) − (b)) = 31,875
In Excel: =MAX(0,Amount*(FixedRate-RedepositRate)*DaysLeft/360). The result is 6.38 bp of the amount prepaid.
The lender demands the figure with the prepayment, and most agreements let it certify the amount, so the borrower's check is arithmetic: the rate it was fixed at, the days left and a redeposit rate it can see on a screen.
| Days remaining | Redeposit 2.15% | 2.65% | 3.10% | 3.40% |
|---|---|---|---|---|
| 10 | 13,194 | 6,250 | 0 | 0 |
| 30 | 39,583 | 18,750 | 0 | 0 |
| 51 | 67,292 | 31,875 | 0 | 0 |
| 70 | 92,361 | 43,750 | 0 | 0 |
| 85 | 112,153 | 53,125 | 0 | 0 |
Break costs are a bet that only one side can lose. If rates have fallen since the fixing, the borrower pays. If they have risen, to 3.40 per cent say, the lender gains €21,250 by redepositing at the higher rate and the borrower receives nothing: the formula is floored at zero. On a six-month period with 142 days left at the same rates, the charge rises to €88,750, which is why borrowers expecting to prepay choose short interest periods.
Prepaying on the last day of an interest period costs no break costs at all, and treasurers often wait for it. On these numbers waiting is the expensive choice.
| Option | Cost over the 51 days |
|---|---|
| Wait: pay interest at 7.10% all-in on the loan | 502,917 |
| less deposit income on the cash at 2.65% | −187,708 |
| Net cost of waiting | 315,208 |
| Prepay now: break costs | 31,875 |
Prepaying today saves €283,333, which is exactly the margin on €50,000,000 for 51 days. Break costs on the standard drafting compensate the funding leg only, so a borrower with the cash in hand is nearly always better off prepaying at once. Many agreements let mandatory prepayments, such as an excess cash flow sweep, wait for the next interest date to avoid break costs. That option is worth using only when the borrower can earn more on the waiting cash than the lender's redeposit rate plus the margin, which is rare: on these numbers it would need a deposit rate above 6.65 per cent.
Some agreements, and many lender calculations sent with a payoff letter, compute the loss at the all-in rate of 7.10 per cent rather than at EURIBOR. On this prepayment that produces €315,208, 9.9 times the standard figure; the extra €283,333 is the lender's margin for the rest of the period. It is also, to the euro, the net cost of waiting computed above, which is the point: a margin-inclusive definition removes any benefit from prepaying mid-period. If the definition says "excluding the Margin", challenge any certificate that does not.
Loans that pay interest on a compounded overnight rate, such as €STR, SONIA or SOFR compounded in arrears, usually carry no break costs, because no rate was fixed in advance for the period. Many agreements written for term rates still contain the clause, so check which rate the prepaid loan actually bears. A prepayment premium or soft call, if the agreement has one, is payable in addition and is a separate clause.
Break costs = amount × (fixed rate less redeposit rate) × days left / 360, never below zero, and excluding the margin unless the clause says otherwise: €31,875 here against €315,208 on the margin-inclusive reading. Check the definition, the fixing, the days and the redeposit rate before paying a certificate. How each prepayment, sweep and fee runs through a complete facility is modelled in the free workbooks for this book, and the fee charged on the undrawn side in how a commitment fee is calculated.
Not under the standard Loan Market Association drafting, which counts interest excluding the margin. Some agreements and payoff letters include it anyway. On an illustrative 50,000,000 euro prepayment with 51 days left, the standard figure is 31,875; computed at the 7.10 per cent all-in rate it is 315,208, of which 283,333 is margin.
No. If market rates have risen since the fixing, the lender earns more by redepositing the money and the formula is floored at zero. With EURIBOR fixed at 3.10 per cent and redeposit rates at 3.40 per cent, an illustrative lender gains 21,250 on a 50,000,000 prepayment with 51 days left, and the borrower receives nothing.
Prepay on the last day of an interest period, choose short interest periods when a prepayment is expected, or borrow on a compounded overnight rate, which usually carries none. Waiting is not always cheaper: holding 50,000,000 for 51 days at 7.10 per cent all-in, less deposit income, costs 315,208, against break costs of 31,875.
This article is one calculation from How to Read a Credit Agreement. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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