What does SOFR plus a spread mean on a loan?

The two parts of the quote

SOFR is published every business day and reflects what it costs to borrow cash overnight against US Treasury securities. Because that market is enormous and collateralized, SOFR carries almost no credit risk. It tracks the Federal Reserve's policy rate closely: when the Fed moves, SOFR follows within days. It replaced LIBOR as the benchmark for US dollar loans when LIBOR was retired.

Business loans rarely use the overnight rate directly. They use term SOFR, a forward-looking rate for one, three or six months, derived from futures markets and published daily. Term SOFR lets a borrower know at the start of an interest period exactly what that period's interest will be, which is how LIBOR loans used to work and how finance teams like to budget.

The spread is the lender's price for your credit. A lender quoting a spread is saying, in effect, what it needs on top of a risk-free base to lend to this business, at this leverage, with this collateral and these covenants. It is set in the credit agreement and does not move with the market. Where there is a pricing grid, the spread steps down as leverage falls and up if it rises, tested each quarter. The spread is where lenders compete, and where the terms of a private credit loan and a bank loan differ most.

You negotiate the spread. You live with SOFR. A lower spread is worth the same every year of the loan; a lower SOFR is worth nothing if the market turns.

How often the rate resets

The borrower usually picks an interest period, most often one month or three months, and can change it at each renewal within the agreement's options. Term SOFR for that tenor is fixed a couple of business days before the period begins, and the loan bears that rate plus the spread for the whole period. At the end, the rate resets to the new term SOFR. Some lenders instead use daily simple SOFR, where the rate changes every day and interest is only known at the end of the period; it is more common in bank facilities with frequent borrowing and repayment, such as revolvers.

The period choice matters less than it looks over the life of a loan, but it changes the timing of rate changes. A three-month period locks in today's term rate for longer; if rates are expected to fall, a one-month period catches the decline sooner. Payment dates usually match the period, so a three-month election also means quarterly interest payments.

The credit spread adjustment, the floor and the day count

When loans moved from LIBOR to SOFR, lenders added a credit spread adjustment to cover the gap between the two benchmarks: LIBOR carried bank credit risk and SOFR does not, so SOFR sits lower. For a loan converted from LIBOR, the adjustment kept the borrower's rate roughly where it had been. On a new loan it has no such purpose. It is simply part of the price, and a quote of SOFR plus an adjustment plus a spread should be read as SOFR plus the sum of the two. Many lenders have dropped the adjustment on new deals; some still show it.

A floor sets a minimum for the base. If term SOFR is below the floor, interest is computed as if SOFR equaled the floor. Floors matter when rates are low or falling, and they interact awkwardly with interest rate hedges, which is covered on the floor page.

Finally, most SOFR loans accrue interest on an actual/360 basis: the annual rate is divided by 360 and charged for each actual day, so a full year of 365 days carries slightly more than the quoted annual rate. It is a small difference, but it is real money on a large balance, and it is one reason two quotes that look identical may not be.

Translating a quote into an all-in cost

The coupon is only the start. To compare two floating-rate offers, or a floating offer against a fixed one, add up everything the borrower pays and spread the one-time items over the time you actually expect to keep the loan. The interest rate versus all-in cost comparison walks through it in full; the components are these:

Take an illustrative loan, with numbers chosen for arithmetic rather than taken from any market: term SOFR of 4.00, a spread of 5.00, and an upfront discount of 2 points. The coupon is 9.00. If the loan is repaid after four years, the discount adds about half a point a year, so the cost is nearer 9.50 before fees and day count. If SOFR rises by one point in year two, every year after that costs one point more, on the whole balance. A cap or swap removes that risk for a price, which is why some lenders require one; see hedging requirements.

SOFR, Prime and fixed rates

Not every floating loan uses SOFR. Community banks and SBA lenders mostly quote off the Prime rate, which moves with the same Fed decisions but sits higher, so Prime-based spreads look smaller for the same all-in cost. SBA sets a legal ceiling on that spread by loan size: on variable 7(a) loans above $350,000, the base rate plus 3%. The SBA maximum rate page lays out the bands, and SOFR versus Prime compares the two benchmarks.

Against a fixed rate, SOFR plus a spread is a bet the borrower makes with the lender's pricing: cheaper if rates fall or hold, dearer if they rise. For a business with thin debt service coverage, the question is not which is cheaper on today's curve but whether the business still covers its payments if SOFR moves against it. Lenders ask the same question. Transparent's financing model sizes debt service on a stressed rate as well as the current one, so the lender presentation answers it before a credit committee does.