What happens if I repay the loan early?

The swap is still there, for its full term and amount, and it has a value: positive to you if fixed rates have risen since you dealt, negative if they have fallen. Closing it out means the bank pays you that value or you pay the bank, which is the break cost borrowers meet when they refinance a fixed-rate arrangement. A swap left in place after the loan it hedged has gone is no longer a hedge; it is a bet on rates.

Should I take a swap or a cap?

A swap fixes the rate in both directions: you give up the fall as well as the rise. A cap sets a ceiling and leaves you floating below it, for a premium paid up front. A business that needs certainty of cost — a fixed-price contract, a thin margin, a lender's covenant — is usually buying a swap; one that can carry a rise but not a disaster is buying a cap. The question to answer first is which of those two businesses you are.

Why does the bank charge for the swap's credit risk?

Because if rates fall after you fix, the swap is worth money to the bank and you owe it the difference over the remaining term — a credit exposure like any other, which the bank prices and may secure under the same security as the loan. It is the reason a swap is approved by credit as well as sold by markets, and the reason the fixed rate you are offered is a little above the market rate for the term.

// WORKED EXAMPLETHE ARITHMETIC A DECISION RESTS ON

An Interest Rate Swap, From the Borrower's Side

Fix the base rate, keep the margin, and know what you have bought.

BY MICHAEL SHANG · SIXTEEN YEARS IN COMMERCIAL BANKING · UPDATED 2026-10-11

// THE SHORT ANSWER

An interest rate swap lets a borrower with a floating-rate loan pay a fixed rate instead without changing the loan: the borrower pays the bank a fixed rate and receives the floating base rate back, so the base rate on the loan is cancelled out and only the fixed rate and the lending margin remain. On a loan at base plus 2.50 with a swap fixed at 4.00, the all-in cost is 6.50 whatever the base rate does. The swap is a separate contract with its own value, which is why repaying the loan early leaves a swap to be unwound at a cost — in either direction.

BASIS Practitioner judgment from sixteen years in commercial banking, set out in How Bankers Think (Highbank Press, 2026). Every borrower on this site is a composite constructed for teaching, not a client. The market is mid-market commercial lending as practised in New Zealand and Australia; where a convention differs elsewhere, the page says so.

// WORK THE SUM

Every Groundwork file that is a number to work out — cash conversion, debt service cover, expected loss, risk-weighted assets, the margin on a bank's own book — with the working shown in the senior read. One minute each, no signup.

Open The Number →

// 01 — THE TWO LEGS

A floating-rate loan charges the base rate plus a margin, and the base rate moves. A swap is a contract that trades the moving part for a fixed one: you pay the bank a fixed rate on the loan's amount, and the bank pays you the floating base rate on the same amount, for the same term.

You pay on the loan: base rate + margin

Under the swap, you pay: fixed rate

Under the swap, you receive: base rate

Net: fixed rate + margin

The base rate you pay on the loan and the base rate you receive under the swap cancel. The margin is not in the swap; it is the price of your credit and it stays on top. The glossary entry defines the instrument; this page works it, and then asks what it is worth once rates have moved.

// 02 — THE EXAMPLE

A business — constructed for this page — borrows US$5m for five years at the base rate plus a margin of 2.50. The base rate today is 3.50. The bank offers a five-year swap at 4.00 fixed.

Without the swap, today: 3.50 + 2.50 = 6.00

With the swap, today: 4.00 + 2.50 = 6.50

With the swap, base at 3.00: 4.00 + 2.50 = 6.50

With the swap, base at 5.00: 4.00 + 2.50 = 6.50

The business pays half a point more than today's floating cost for the certainty that the cost will be 6.50 whatever happens. If the base rate falls to 3.00 the swap costs it a point a year; the bank receives 4.00 and pays 3.00. If the base rate rises to 5.00 the swap pays it a point; the bank receives 4.00 and pays 5.00. That is the whole of what was bought: not a cheaper loan, a known one.

// 03 — WHAT THE SWAP IS WORTH AFTER RATES MOVE

A swap has a value of its own from the day it is dealt, and the value moves with fixed rates. If, a year in, five-year swaps are dealing at 3.00, this business is paying 4.00 for four more years on US$5m — a point a year, roughly US$50,000 a year, about US$190,000 in today's money across the remaining term. That is what it would cost to close the swap out. Had rates gone the other way, the bank would pay the business to close it.

Three consequences follow, and they are the ones a borrower meets later rather than at the signing. Repay the loan early and the swap stays, with that value owing one way or the other. Fix more than you have borrowed, or for longer than the loan runs, and the excess is not a hedge but a position. And the bank treats the amount you might owe under the swap as credit exposure, which is why the fixed rate carries a small charge above the market and the swap sits under the loan's security.

WORK IT · THE NUMBER → · OVER-HEDGING, THE FIRST QUESTION → · A CAP AGAINST A SWAP → · BREAK COST, DEFINED →

// 04 — WHERE IT DECIDES A FILE

From the bank's side, a fixed rate agreed for a borrower is a fixed-rate asset against floating deposits, and the swap is how the bank hands that position back to the market — the mechanism on the net interest margin page. From the borrower's side, the decision is fixed or floating, and a credit desk reads it as a risk allocation, not a forecast: cover tested at today's rate and at a higher one, and the swap recommended when cover at the higher rate would fail.

FIXED VS FLOATING → · A SWAP AS A HEDGE, THE CALL → · A FORWARD, FOR AN EXPORTER →

// STANDARDS THIS SITS BESIDE

The recognised ground this page sits beside. Each was opened and checked when cited; none is a source for the framework itself.

Banking Ombudsman Scheme (New Zealand), Case note 62400: Bank applied early repayment interest charge correctly (December 2019) — On a fixed-rate business loan repaid a year early, the break cost was upheld because it was disclosed in the contract, calculated by its method and based on wholesale rates matching the Reserve Bank's published swap rates — what it costs to close a fixed rate once rates move, section 03.
European Banking Authority, Guidelines on loan origination and monitoring (EBA/GL/2020/06), section 5.2.6, paragraphs 156–158 — A lender tests a business borrower's repayment capacity under severe but plausible events, including a rise in its cost of funding — cover at today's rate and a higher one, in section 04.
Basel Committee on Banking Supervision, Interest rate risk in the banking book (April 2016) — Gap risk arises from the timing of rate changes between a bank's assets and its funding — the fixed-rate asset against floating deposits that the bank hedges, section 04.

// QUESTIONS PEOPLE ASK

Does a swap change my loan?: No. The loan stays floating — base rate plus the margin, drawn and repaid on its own terms. The swap is a second contract beside it, under which you pay a fixed rate and receive the base rate, so the base rate you pay on the loan and the base rate you receive under the swap cancel. What you are left paying is the fixed rate plus the loan's margin. Change the loan — repay it, reduce it, extend it — and the swap does not follow; it has to be changed separately.
What happens if I repay the loan early?: The swap is still there, for its full term and amount, and it has a value: positive to you if fixed rates have risen since you dealt, negative if they have fallen. Closing it out means the bank pays you that value or you pay the bank, which is the break cost borrowers meet when they refinance a fixed-rate arrangement. A swap left in place after the loan it hedged has gone is no longer a hedge; it is a bet on rates.
Should I take a swap or a cap?: A swap fixes the rate in both directions: you give up the fall as well as the rise. A cap sets a ceiling and leaves you floating below it, for a premium paid up front. A business that needs certainty of cost — a fixed-price contract, a thin margin, a lender's covenant — is usually buying a swap; one that can carry a rise but not a disaster is buying a cap. The question to answer first is which of those two businesses you are.
Why does the bank charge for the swap's credit risk?: Because if rates fall after you fix, the swap is worth money to the bank and you owe it the difference over the remaining term — a credit exposure like any other, which the bank prices and may secure under the same security as the loan. It is the reason a swap is approved by credit as well as sold by markets, and the reason the fixed rate you are offered is a little above the market rate for the term.

THE IN-TRAY · ONE MINUTE

Make the call on one file.

A short file on the ground this page covers. Every option opens with how far it sits from a senior banker’s read.

THE NUMBER · THE LOAN · HEDGES

A borrower pays a floating rate on a five-year term loan: the base rate plus a margin. It enters a swap with the bank, paying a fixed rate and receiving the base rate.

Lending margin: 2.50
Swap fixed rate: 4.00
Base rate today: 3.50

What does it pay all-in, and what if the base rate falls to 3.00?

6 MORE ON THE LOAN · HEDGES →WHERE DO YOU READ FROM? THE PLACEMENT →