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A soft loan is a loan extended on terms that are more favorable than what the borrower could obtain in the commercial market. Favorable terms can include a below-market interest rate, an extended repayment period, a long grace period during which no principal or interest payments are required, or some combination of all three. Soft loans are also called concessional loans or concessional financing. They are primarily used as a development finance tool, issued by governments, the World Bank, the International Monetary Fund, and multilateral development banks to support developing countries and low-income nations.
Think of a soft loan like lending your sibling money at zero interest when they are starting a business: you are deliberately sacrificing market-rate returns to support their development.
Soft loans are offered by entities whose mandate includes development, poverty reduction, or diplomatic goals, not profit maximization. The primary lenders include the World Bank's International Development Association, which provides zero or near-zero interest loans to the poorest countries; bilateral development agencies such as USAID, Japan International Cooperation Agency, and similar government bodies; regional development banks including the Asian Development Bank, African Development Bank, and Inter-American Development Bank; and individual governments extending loans to allies or trading partners as part of foreign aid programs.
The rationale is that low-income countries cannot afford commercial market interest rates. Requiring a developing country to service a 7% or 8% loan often leaves it unable to fund essential public services. A soft loan at 1% or 2% with a 40-year repayment term makes the debt burden manageable while still funding infrastructure, education, or public health programs the country needs.
The Organisation for Economic Co-operation and Development defines concessional loans by their grant element, which measures how much cheaper the loan is compared to a benchmark market rate. For a loan to be classified as official development assistance, it must have a grant element of at least 25% calculated at a 10% discount rate. In practice, many International Development Association loans carry maturities of 25 to 40 years, grace periods of 5 to 10 years, and service charges of 0.75% to 1.25% per year.
Soft loans must still be repaid, even if the terms are generous. Grants are outright transfers that do not require repayment. A soft loan creates a debt obligation on the recipient country's balance sheet, which affects its debt sustainability calculations and future borrowing capacity. However, because soft loans often come with technical assistance, reporting requirements, and policy conditions, they are sometimes viewed as more structured and accountable than unrestricted grants.
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