The ratio between the two cures is independent of how deep the income decline is, and entirely dependent on the covenant level and the amortisation schedule.
A borrower breaches a 1.20× coverage covenant after a 20 per cent fall in income. It can cure with a deposit or by prepaying principal. The deposit costs 233,192. The prepayment costs 2,602,535 — 11.2 times as much. That ratio is not a feature of this loan, and it is not a feature of the size of the decline either. It is 1/(k·c), and both letters are negotiated at closing.
Worked in full in How to Read a Real Estate Loan Agreement by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Practitioners get the first half of this right by instinct: the ratio between the two cures does not depend on how bad things get. What almost nobody says is the second half, which is that it depends entirely on the coverage covenant and the amortisation schedule — the two terms a borrower actually negotiates, usually without knowing this is one of the things being negotiated.
A stabilised asset appraised at 62 million, financed at 60 per cent loan to value on a thirty-year schedule. The mortgage constant is 7.467 per cent, so debt service is 2,777,660 and coverage today is 1.395 times. Debt yield is 10.42%. The covenant ladder has four rungs.
| Trigger | NOI required | Decline from today |
|---|---|---|
| Coverage 1.20× — cash trap | 3,333,192 | -14.0% |
| Debt yield 8.50% — cash trap | 3,162,000 | -18.4% |
| Coverage 1.10× — cash sweep | 3,055,426 | -21.2% |
| Coverage 1.05× — event of default | 2,916,543 | -24.7% |
Income falls 20 per cent, to 3,100,000. The coverage test now fails. A deposit cure tops up the numerator: put in enough cash that the ratio reads 1.20× again. A prepayment cure shrinks the denominator: repay principal until the reduced debt service is covered.
| At a 20% income decline | Amount |
|---|---|
| Income after the decline | 3,100,000 |
| Cure by deposit — top the coverage ratio back to 1.20× | 233,192 |
| Cure by prepayment — shrink the loan until 1.20× holds | 2,602,535 |
| The ratio between them | 11.2× |
Both cures fix exactly the same breach and leave the lender in exactly the same covenant position. One costs eleven times the other. Which of the two the loan agreement gives you is therefore worth roughly 2,369,343 in this scenario, and the clause that decides it usually runs to two sentences.
Write both cures out. The deposit is k·DS − I. The prepayment is L − I/(k·c), because the loan must shrink until k times the new debt service equals income, and debt service is the balance times the constant. Substitute DS = L·c and the income term cancels out of the ratio:
prepayment / deposit = 1 / (k · c)
| Income decline | Deposit cure | Prepayment cure | Ratio |
|---|---|---|---|
| -15% | 39,442 | 440,194 | 11.16 |
| -18% | 155,692 | 1,737,599 | 11.16 |
| -20% | 233,192 | 2,602,535 | 11.16 |
| -25% | 426,942 | 4,764,877 | 11.16 |
| -30% | 620,692 | 6,927,218 | 11.16 |
Neither k nor c is a market fact. The coverage covenant is negotiated line by line. The mortgage constant is set by the amortisation schedule, which is negotiated in the same session — and usually traded away for a few basis points on the rate.
| Amortisation | k = 1.15 | k = 1.20 | k = 1.25 | k = 1.30 |
|---|---|---|---|---|
| Interest only | 13.69 | 13.12 | 12.60 | 12.11 |
| 30 years | 11.65 | 11.16 | 10.71 | 10.30 |
| 25 years | 10.88 | 10.43 | 10.01 | 9.63 |
| 20 years | 9.84 | 9.43 | 9.05 | 8.70 |
From 8.70 times to 13.69 times across that grid. A borrower who concedes ten years of amortisation to shave the coupon — twenty-five years instead of thirty-five, say — has also cut the leverage of its deposit cure by roughly a fifth, and nobody prices that at the table. It costs nothing to compute before the session and it is unrecoverable afterwards.
A deposit cure only works while the coverage test is the binding one. There is a second trigger on the ladder — the debt yield trap at 8.50% — and a deposit does nothing for it, because debt yield has no debt-service term to top up. Income is income.
The coverage trap fires at a 14.0% income decline. The debt yield trap fires at 18.4%. Between them is a window of 4.42 points of income decline in which the cheap cure works, and outside it only a prepayment does.
| Debt yield covenant | Fires at an income decline of | Window, points |
|---|---|---|
| 8.00% | -23.2% | 9.22 |
| 8.25% | -20.8% | 6.82 |
| 8.50% | -18.4% | 4.42 |
| 8.75% | -16.0% | 2.02 |
| 9.00% | -13.6% | -0.38 |
So the deposit cure has the shape of an option that expires exactly when it acquires value: cheap while the decline is shallow enough that a sponsor could probably have funded the shortfall anyway, unavailable once the decline is deep enough to hurt. That does not make it worthless — a four-point window is real and most income declines are shallow — but it makes its value bounded, and the bound is 1,910,586, computable on the day the loan closes. A debt yield covenant at 8.00 rather than 8.50 more than doubles the range over which the cheap cure works, which is the negotiation that number argues for.
It is easy to size a cure against the wrong threshold. Origination tests and covenant thresholds are different numbers that look alike: this loan was sized at a 9.00 per cent debt yield and its covenant trap is at 8.50. Curing back to 9.00 restores a test the loan does not impose.
| Income decline | Debt yield | Cure to 9.00% | Cure to 8.50% | Overshoot |
|---|---|---|---|---|
| -18% | 8.54% | 1,894,444 | 0 | no breach to cure |
| -20% | 8.33% | 2,755,556 | 729,412 | 3.78× |
| -22% | 8.12% | 3,616,667 | 1,641,176 | 2.20× |
| -25% | 7.81% | 4,908,333 | 3,008,824 | 1.63× |
| -30% | 7.29% | 7,061,111 | 5,288,235 | 1.34× |
Read the first row. At an 18 per cent decline the debt yield is 8.54% — above the 8.50 per cent trap. There is no breach at all, and a cure sized to the origination test prepays 1,894,444 to fix it. At a 20 per cent decline, where there is a real breach, curing to 9.00 rather than 8.50 prepays 3.78 times what the covenant requires.
Compute 1/(k·c) for the loan in front of you and write it on the page: it is the multiplier on every future cure decision and it takes one formula. Compute the window between the coverage trigger and the debt yield trigger, because that is the range over which the cheap cure exists. And when a cure is proposed, check which threshold it restores — the covenant, or the test the loan was sized against.
None of these is a modelling exercise. They are three numbers that exist the day the loan closes and are usually computed, if at all, on the day they stop being useful.
This article is one calculation from How to Read a Real Estate Loan 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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