Quick background

Loan covenants are promises embedded in loan contracts that limit borrower actions (negative covenants), require certain behaviors (affirmative covenants), or set financial thresholds (financial covenants). Lenders use them to monitor credit risk and preserve collateral. When circumstances change, borrowers may need term changes—but unilateral changes can trigger defaults, cross-defaults, or acceleration.

A practical step-by-step process to modify terms safely

  1. Review the loan agreement and identify covenant types and triggers. Focus on any financial ratios, reporting deadlines, or restrictions on additional debt. (See our guide to Key Clauses in a Loan Agreement Every Borrower Should Read.)
  2. Quantify the need. Prepare updated financial statements, a 6–12 month cash‑flow forecast, and a short recovery plan showing how the modification restores covenant compliance.
  3. Classify the solution you’ll request: waiver (temporary relief), amendment (permanent change), forbearance (defer payments), extension, or refinancing. Different fixes have different documentation and cost implications.
  4. Anticipate lender concerns—credit quality, collateral value, and covenant creep—and prepare mitigants (e.g., additional reporting, reserve accounts, or temporary fees).
  5. Propose a written amendment or forbearance letter with clear start/end dates, measurement points, and consequences for re-default. Use precise language to avoid ambiguity.
  6. Obtain written lender consent. Oral promises don’t change contract terms—get the amendment executed and recorded where needed.
  7. Update internal controls and creditors. Track the new measurement dates and required filings so you don’t inadvertently re-breach the covenant.

In my practice advising small-business and commercial borrowers, proactive, data-backed proposals and a willingness to offer short-term concessions (e.g., a modest covenant to replace a waived covenant) increase the chance a lender will cooperate.

Common modification options and tradeoffs

  • Waiver: temporary permission to ignore a covenant—usually quicker but may carry fees and restrict future flexibility.
  • Amendment: formal, permanent change—more documentation and legal review but cleaner long term.
  • Forbearance: temporary payment relief—can preserve liquidity but interest often continues to accrue (see our piece on interest during forbearance or modification).

Real-world example (short)

A small retail borrower experienced a two-quarter revenue dip. They presented two quarters of updated financials, a revised 12-month cash-flow forecast, and agreed to extra monthly reporting. The lender issued a three-month waiver and a written amendment requiring a revised covenant test at month four—avoiding acceleration.

Who is affected / eligible

Any borrower with a loan containing covenants may seek modifications: consumers with mortgages or auto loans, small-business owners, and corporations. Eligibility depends on the lender’s underwriting policies, the borrower’s remaining collateral and cash flow, and the negotiation package presented.

Negotiation tips professionals use

  • Approach early: lenders are more flexible before missed payments pile up.
  • Be concise and credible: provide supporting documents and a realistic recovery timeline.
  • Offer compensating protections: additional reporting, temporary pricing adjustments, or more collateral reduce lender risk.
  • Know the mechanics: propose exact amendment language and who signs it (borrower, guarantor, collateral agent).

Common mistakes to avoid

  • Relying on verbal promises—only executed amendments protect you.
  • Ignoring cross-default clauses tied to other obligations.
  • Failing to model the effect of deferred interest or fees on long-term affordability.

Short FAQ

Q: Can I change terms without lender approval?
A: No. Unilateral changes typically breach the contract. Always get written consent (see Consumer Financial Protection Bureau guidance on loan modification interactions) (Consumer Financial Protection Bureau: https://www.consumerfinance.gov/).

Q: What if the lender refuses?
A: Consider refinancing, selling assets, or seeking a formal workout through intermediaries (for small businesses, the SBA has resources on lender workouts) (U.S. Small Business Administration: https://www.sba.gov/).

Professional disclaimer

This article is educational and not legal or accounting advice. Consult your attorney, CPA, or a qualified financial advisor before signing amendments or waivers.

Authoritative sources

Related reading: Loan Modification Negotiation: How to Propose a Sustainable Plan and What Happens to Interest During a Loan Forbearance or Modification.