Debt Limitation

DEFINITION of 'Debt Limitation'

A bond covenant that limits or restricts any additional debt that may be incurred by the issuer. Debt limitations look to protect the current lenders by maintaining the firm's degree of leverage.

BREAKING DOWN 'Debt Limitation'

A debt limitation may take a variety of forms, depending on the circumstances of the debt issue. For financially sound firms, lenders may only want to maintain the current levels of leverage and implement a covenant relating to the debt-service coverage ratio. This would allow the firm to borrow more funds when it increases its net income.

If the firm appears risky, lenders may not want it to incur additional debt. The covenant may specify a maximum level of debt, despite any growth in operations. In more extreme cases, the lenders may demand that no additional debt be incurred until their bonds are repaid.

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