For a couple of years the only question anyone asked about floating rate debt was when the cuts would come. That changed on September 16, when the Fed raised its target range a quarter point to 3.75% to 4.00%, its first increase since 2023, and nobody on the committee dissented. The median projection released the same day has rates finishing this year around 4.1% and sitting there through 2027; back in June, the same group had 2027 at 3.6%. So if your revolver and term loan float off SOFR, the interest rate cap vs swap conversation your banker brought up last year is probably worth having again before the next meeting on October 27 and 28.
Start with one number: what a quarter point costs you
Before anyone sends you a hedge quote, work out your own exposure in dollars. Take the floating balance you expect to carry over the next twelve months (the drawn amount, not the size of the facility) and multiply it by 0.25%. With $40 million drawn, a quarter point is about $100,000 a year of extra interest. Two more hikes would make it $200,000, which for plenty of mid market companies is a salary, or a covenant test that suddenly isn't the formality it was in the spring.
It sounds too basic to mention. But when the September hike landed and we checked it against what companies had disclosed about their debt, a surprising number of filings didn't say whether the revolver was fixed or floating, which benchmark it used, or whether it had a floor. Outsiders often can't work out what 25 basis points does to you, and plenty of boards can't either until somebody puts the figure on a slide for them.
How an interest rate swap for a business loan works
In a swap you agree to pay a fixed rate on a set notional amount and receive floating SOFR in return. The SOFR you receive offsets the SOFR on your loan, so what's left is the fixed swap rate plus whatever credit spread your lender charges. The spread is the part that catches people out, because the swap does nothing to it, a point Pinnacle makes in its own primer.
Price is the awkward bit right now. The New York Fed had overnight SOFR at 3.87% on October 8, and three to five year SOFR swap rates were a little above 4.7% the following day, going by BlueGamma's published rates. So the market has already built more hikes into the curve. Swap $40 million today and you'd pay roughly 0.8% more than floating from day one, something like $330,000 a year, and you'd only come out ahead if SOFR averages above that fixed rate over the life of the swap. That can still be the right trade. I'd just want everyone in the room, the board especially, to understand they're paying up for certainty, because calling it a locked-in low rate is going to age badly.
Then there's breakage. Refinance or pay down early after rates have fallen and you'll owe the difference on the swap; if rates have gone up instead, the swap can be worth money to you. Either way it's a real number, and it belongs in any refinancing model you build.
What a SOFR interest rate cap costs, and when it beats the swap
A cap works more like insurance. You pay a premium upfront, and if SOFR rises above the strike, the counterparty pays you the difference on the notional. If rates drop, you get the benefit and all you've lost is the premium. Chatham Financial lists the inputs that drive the price (notional, term, strike, volatility) and points out that the third year of a cap often costs more than the first two put together, which is reason enough to price a two year and a three year side by side before assuming longer is better.
I can't give you a reliable public figure for what a cap on your loan would cost, and I'd be suspicious of anyone online who does. Get quotes at two or three strikes. In my view a cap fits best when you expect to refinance, sell or pay the debt down inside the term, since you don't want breakage sitting on top of a transaction. A swap tends to suit debt that's going to sit there for years, where budget certainty matters more to the board than the chance of rates falling. And staying floating is a perfectly legitimate choice if your cash flow and covenant headroom can handle the number from the first section.
What to bring to the bank
The swap desk will happily quote you. A few things to sort out before that call:
- Pick the notional yourself. Hedge the debt you're confident will still be outstanding rather than the whole facility. Revolver balances move around, and the low point in your 13-week cash flow forecast is a sensible place to start.
- Match the term to how long you expect the debt to live, which may be shorter than the maturity date if a refinancing is already on your mind.
- Ask for the mid-market rate. The rate a bank quotes includes its own margin, and you won't see it unless you ask or pay an independent advisor to check.
- Get the breakage terms in writing, including what happens if you refinance with a different lender in year two.
- Have the credit agreement open to the hedging section. Plenty of term loans require you to hedge some share of the balance within a set window after closing, and the swap often sits inside the loan's collateral, which is part of why banks like being the counterparty.
If you'd like this applied to your own debt, a free briefing reads each rate decision against the facilities you've told us about.
CFOmarketIQ reads rate decisions, credit conditions and the rest of the week's news against your own debt and margins, and the first briefing is free.
Questions CFOs ask about interest rate hedging
What is the difference between an interest rate cap and a swap?
A swap turns your floating SOFR payments into a fixed rate for a set term. There's no upfront cost, but you may owe breakage if you exit early. A cap is bought upfront and pays you when SOFR climbs past a strike rate, while letting you keep the savings if rates fall. Neither one touches your lender's credit spread.
How much does an interest rate cap cost?
It depends on the notional, the term, the strike and market volatility, and there's no reliable public price list to point to. Ask for quotes at two or three strikes and a couple of terms. Later years of a cap often cost more than the early ones, so a shorter cap can be a lot cheaper.
Should I hedge my floating rate loan now?
Start by working out what a quarter point costs you in dollars, then ask whether your cash flow and covenants could absorb a few more of them. If not, a hedge buys certainty. Swap rates currently sit above overnight SOFR, though, so a swap costs more than floating on day one and only pays off if rates keep climbing.
Does a swap cover the credit spread on my loan?
No. A swap only replaces the SOFR benchmark with a fixed rate, and you still pay your lender's credit spread on top. That spread can also change if the loan gets repriced, amended or refinanced, so budget the all-in rate as the swap rate plus the spread.
A note on all of this: it is general information, not financial, legal or tax advice. Run anything you plan to act on past your own advisors first.