A forward loan is an option that allows borrowers to secure currently low interest rates for future financing. This means that a loan is pre-arranged but will not be drawn down until a later, fixed date. Forward loans are often used for mortgages, especially when existing loan agreements expire and follow-up financing is needed. Here are two examples to illustrate the use of forward loans:
Follow-up financing for an expiring mortgage: A borrower has a mortgage with a term of 10 years, which ends in two years. However, they expect interest rates to rise in the near future. To hedge against these interest rate increases, the borrower decides to take out a forward loan, which allows them to secure the current lower interest rates for future follow-up financing.
Prospective real estate financing: A couple plans to buy a house in three years. They expect interest rates to rise over the following years, which would make financing their property pricier. To mitigate that risk, they decide to take out a forward loan, which allows them to lock in the current lower interest rates on their future mortgage.
It should be noted that forward loans are often linked to a forward period, i.e. the period between the conclusion of the loan agreement and the actual start of the loan term. The length of the forward period can vary, but it is typically between 12 and 36 months. During this period, there are usually no interest payments, but the lender may claim an interest rate surcharge to cover the risk of interest rate changes.