What is a loan covenant?
A covenant is a condition in a loan agreement that the borrower agrees to meet while the loan is outstanding. It can require you to do something, such as keep insurance or send financial statements, or to refrain from something, such as selling collateral or taking on more debt without permission.
Covenants protect the lender by giving early warning when a farm's finances weaken. They also give you a clear list of what is expected of you.
Read the covenants section of the loan agreement before you sign, not after. The page count can look long, but the covenants are often only a few pages.
What types of covenants are common on farm loans?
They fall into a few groups. Affirmative covenants require actions, negative covenants limit them, and financial covenants set targets for ratios or balances. Which ones you have depends on the lender, the size of the loan and the risk.
Smaller loans may carry only a few covenants. Larger or more complex loans often have several, and each should be read carefully.
Ask the lender for a plain-language list of every covenant in your agreement and the date each is due or tested.
- Reporting: financial statements, tax returns, borrowing base reports
- Insurance: keeping crop, property and liability coverage
- Negative: limits on additional debt, asset sales, large withdrawals or new liens
- Financial: minimum current ratio, working capital or debt service coverage
- Maintenance: keeping collateral in good condition
How do financial covenants work?
A financial covenant sets a target that the farm must meet and is tested on a set date, often annually. Examples include keeping current assets above a multiple of current liabilities, keeping working capital above a stated level, or keeping the debt-to-asset ratio below a limit. The specific numbers are negotiated in each loan.
Because the ratios come from your statements, the way you value assets and treat accrual adjustments can affect whether you pass. Ask how the lender will calculate each test and which values count.
Some tests use averages or year-end numbers. A big sale or purchase just before the test date can change the result, so plan the timing of major moves.
What happens if you violate a covenant?
A covenant violation is a breach of the agreement, even if every payment is on time. The lender may waive it, ask for a fix, change the terms, raise the rate, require more collateral or, in serious cases, demand repayment. Most lenders prefer a conversation to enforcement, particularly with borrowers who raise problems early.
Read the agreement for what it says about notice and cure periods. If you see a violation coming, contact your lender before the test date.
A waiver should be in writing. A friendly conversation is good, but a signed waiver is the record you will want if staff or ownership changes.
How do you stay in compliance?
Make a covenant calendar listing every reporting date, insurance renewal and ratio test. Update your numbers during the year so you are never surprised by year-end results. Share the list with your bookkeeper and CPA.
If a planned purchase or sale would trigger a negative covenant, ask your lender for written consent first. A short email can prevent a large problem.
Keep your insurance agent and accountant informed, since lapses and missing reports are among the easiest violations to avoid.
Can covenants be negotiated?
Often yes, especially before you sign. You might ask for different ratio levels, more time to deliver statements or a cure period. Lenders are more flexible when the borrower shows a solid record and good reporting.
Have an agricultural attorney review the loan agreement before signing if the loan is large or the terms are unclear. It costs little compared with the risk of a covenant default.
If you lose a negotiation point, ask about a review after a year of good performance.
Which questions should you ask before signing?
Ask which covenants are tested, how often, and on whose numbers. Ask what the lender does first if a test is missed, and whether there is a cure period. Ask who to call if you expect trouble.
Written answers are best. If the response is vague, ask for the sentence in the agreement that controls the issue.
Key takeaways
- Covenants are promises in the loan agreement that you must keep, even when payments are current.
- Types include reporting, insurance, negative and financial covenants.
- Know how your lender calculates each financial test.
- Keep a calendar and talk to your lender before a likely violation.
- Ask for changes before you sign, and have an attorney review large agreements.
Sources and official links
Last reviewed: November 12, 2026. Written by the Farm Money & Grants Editorial Team. Educational only, not tax, legal or financial advice. See our editorial policy.