Leveraged Loans Explained 2025: Costs, Risks, and Real-World Examples

Ariel Courage is a seasoned editor, researcher, and former fact-checker renowned for her work with top finance publications like The Motley Fool and Passport to Wall Street.

What Are Leveraged Loans in 2024?

Leveraged loans are specialized loans extended to companies or individuals who already carry significant debt or possess a low credit rating. Because these loans involve greater default risk, lenders charge higher interest rates to offset potential losses.

These loans often feature floating interest rates tied to benchmarks such as the Secured Overnight Financing Rate (SOFR), which replaced LIBOR in mid-2023, plus an added margin to reflect increased credit risk.

Key Points to Remember

• Leveraged loans target borrowers with substantial existing debt or sub-investment grade credit scores.
• Lenders price these loans higher due to elevated risk of default.
• Interest rates on leveraged loans typically exceed those of conventional loans, compensating for added risk.

How Leveraged Loans Are Structured

These loans are arranged by commercial or investment banks known as arrangers who may syndicate portions of the loan to other investors, spreading the risk. The terms are often flexible—if investor demand is low, arrangers may increase the interest margin (price flex upward). Conversely, strong demand can lead to margin reductions (price flex downward).

The classification of a loan as leveraged often depends on the borrower's credit rating, with ratings below Ba3 by Moody's or BB- by S&P signaling leveraged status.

Practical Uses of Leveraged Loans by Businesses

Companies frequently deploy leveraged loans to fund mergers and acquisitions (M&A), refinance existing debt, restructure their balance sheets, or support general corporate needs. A common scenario is a leveraged buyout (LBO), where a public company is purchased and taken private using substantial borrowed funds.

Note:

While leveraged loans enable borrowing despite poor credit or heavy debt, they carry higher borrowing costs.

Real-World Example of a Leveraged Loan

Credit agencies classify loans rated Ba3 or below (Moody’s) or BB- or below (S&P) as leveraged. Such loans generally have floating interest rates tied to SOFR plus a risk premium.

Comparing Bank Loans and Leveraged Loans

Leveraged loans, also called floating-rate or bank loans, are originated by banks and sold to investors. These loans are secured by assets like real estate, equipment, or intellectual property, and are typically used by companies with below-investment-grade credit ratings to finance growth or refinance debt.

Investment Funds and Leveraged Loans

Mutual funds and ETFs may include leveraged loans to boost returns, attracted by their higher interest yields despite increased risk. Fund managers adjust exposure based on investment goals and market conditions.

Summary

In 2024, leveraged loans remain a vital financing tool for highly indebted or lower-rated borrowers. Their higher interest rates reflect greater default risk, and they are structured flexibly to meet market demands. Understanding these loans is essential for investors and companies navigating complex financial landscapes.

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