A forward-starting swap begins exchanging payments on a future date, typically aligned with a known refi closing or open prepay window. It locks the fixed rate today for that future loan, eliminating rate risk between today and the start date. Cost: forward rate plus a small forward premium.
When forward swaps make sense and what they cost
Use case 1: refinancing into a known maturity. Sponsor has an existing loan maturing in 9 months and plans to refinance with a new 10-year fixed-rate perm. A forward-starting swap entered today locks the rate on the future loan; the borrower exchanges floating-for-fixed starting 9 months from now.
Use case 2: open prepay window in the future. Sponsor's existing loan opens to prepay in 12 months. Forward-starting swap locks the new-loan rate today; the borrower waits out the prepay window without rate exposure.
Pricing: the forward swap rate equals today's spot swap rate adjusted for the forward curve. If the curve is upward-sloping (typical), the forward rate exceeds the spot rate. The forward premium is the cost of the lock; in flat-curve environments it is small, in steep-curve environments it can be 25 to 50 bps over spot.
Risks: the forward swap commits the borrower to enter the new loan on the start date or unwind the swap at then-current market value. If the refi falls through or the start date moves, the unwind cost can be substantial. Match the forward swap's start date to the highest-confidence closing date and have a Plan B for unwind.
Documentation: ISDA Master Agreement plus a forward-starting Confirmation. Counterparty selection follows the same logic as a spot swap or cap RFP, credit rating, lender-relationship pre-clearance, and execution speed.
Sources
- Secured Overnight Financing Rate (SOFR) · Federal Reserve Bank of New York · daily
- Treasury Constant Maturity Series (DGS5, DGS10) · Federal Reserve Bank of St. Louis (FRED) · weekly
- Daily Treasury Par Yield Curve Rates · U.S. Department of the Treasury · daily