Line of credit / revolving credit

A line of credit is a lending facility that gives a borrower access to funds up to an agreed limit, which they may draw down, repay and draw again as needed. Interest is charged only on the amount actually outstanding, not on the limit.

Revolving credit describes the redrawing feature: as principal is repaid, the availability is restored and can be used again. The facility "revolves" rather than running down to zero on a fixed schedule. Overdrafts and credit cards are the most familiar examples; business working capital facilities and borrowing base lines work the same way at larger scale.

The contrast with a term loan is the whole point of the product:

• Funds released: Term loan is disbursed once, in full; line of credit is drawn on demand, in part, whenever needed.
• Balance: Term loan declines on a schedule; line of credit fluctuates with use.
• Interest charged on: Term loan charges on full principal from day one; line of credit charges only on the drawn balance, day by day.
• Repayment: Term loan requires fixed instalments; line of credit requires a minimum payment or is repayable on demand.
• Once repaid: Term loan facility is closed; line of credit availability is restored.
• Suits: Term loan suits a known, one-off need; line of credit suits a recurring, variable, or uncertain need.

A business that needs 400,000 to buy a machine wants a term loan. A business that needs somewhere between zero and 400,000 depending on the month wants a line of credit. Matching the structure to the shape of the need is the substance of the decision; getting it wrong is expensive in one direction and dangerous in the other.

The mechanics

Limit. The maximum that may be outstanding at any time. It is a ceiling on the balance, not a total the borrower may cumulatively draw — a borrower may draw and repay many times the limit over the life of the facility.

Availability. Limit less current balance, less any amounts committed but not yet settled.

Drawdown. A request to release funds, either freely up to the limit or, in borrowing base facilities, supported by eligible assets.

Accrual. Interest is normally calculated on the daily outstanding balance and charged monthly. This is the operational difference that matters most: there is no amortisation schedule to follow, because the balance is not knowable in advance.

Minimum payment. For consumer revolving products, a required monthly payment expressed as a percentage of the balance or a fixed floor, whichever is greater.

Review date. Facilities are granted for a period — commonly twelve months — and renewed, amended or withdrawn on review. A line of credit is not permanent funding, however long it has been rolled.

Committed and uncommitted, secured and unsecured

Committed facilities oblige the lender to advance funds when requested, provided the conditions are met. The borrower can rely on the money being there, and pays a commitment fee on the undrawn portion for that certainty.

Uncommitted facilities are made available at the lender's discretion and are usually repayable on demand. They are cheaper and less reliable. Most small business overdrafts fall here, which is why a borrower who treats an overdraft as permanent capital is exposed to a withdrawal they cannot control — typically at the moment their business looks weakest, which is exactly when the lender reviews it.

Secured lines are supported by collateral — property, a debenture over the business, a cash cover, or a pool of receivables and stock. Unsecured lines rely on the borrower's standing alone and carry smaller limits and higher pricing.

A borrowing base facility links availability directly to eligible assets, recalculated regularly:

Availability = (Eligible receivables × advance rate) + (Eligible stock × advance rate) − Reserves

This is the same logic as invoice financing, operated as a revolving limit rather than invoice by invoice. As sales grow, the base grows and so does availability — which is the property that makes it suit expanding businesses.

What it costs

Pricing for a revolving facility usually has three components, and comparisons that look at only the first are misleading:

• Interest: Charged on the daily drawn balance as a rate per month or per annum.
• Commitment or facility fee: Charged on the undrawn portion as a small percentage per annum.
• Arrangement or renewal fee: Charged on the limit as a one-off percentage at grant and at each renewal.

Penalty pricing on balances above the limit, and higher rates once the facility is out of order, are common additions.

Worked example: revolving against term

A business has a limit of 500,000 at 2.5% per month on the drawn balance, plus 0.5% per annum on the undrawn portion. Its need is seasonal.

• Month 1: Drawn balance 200,000 — Interest: 5,000 | Commitment fee: 125
• Month 2: Drawn balance 350,000 — Interest: 8,750 | Commitment fee: 63
• Month 3: Drawn balance 100,000 — Interest: 2,500 | Commitment fee: 167
• Quarter total: Interest: 16,250 | Commitment fee: 355

Total cost for the quarter: 16,605.

A 500,000 term loan at the same 2.5% monthly rate would cost 12,500 per month in interest regardless of use — 37,500 for the quarter — because the borrower pays for money they do not need in months one and three.

The comparison reverses when the facility is fully drawn. Revolving facilities are priced above term loans for the same borrower, precisely because the lender must hold capital against an amount that may be drawn at any time. A borrower permanently at their limit is paying a flexibility premium for flexibility they are not using, and should be refinanced into a term loan.

The minimum payment trap

Where repayment is set as a percentage of the outstanding balance, the balance declines geometrically and very slowly. A borrower with 50,000 outstanding, interest at 3% per month and a minimum payment of 5% of the balance:

• Month 1: Balance 50,000 | Payment: 2,500 | Interest: 1,500 | Principal reduction: 1,000
• Month 12: Balance 39,235 | Payment: 1,962 | Interest: 1,177 | Principal reduction: 785
• Month 24: Balance 30,790 | Payment: 1,540 | Interest: 924 | Principal reduction: 616
• Month 36: Balance 24,166 | Payment: 1,208 | Interest: 725 | Principal reduction: 483
• Month 60: Balance 14,880 | Payment: 744 | Interest: 446 | Principal reduction: 298

Five years of unbroken minimum payments and the borrower still owes nearly a third of the original balance, having paid substantially more than that in interest along the way. The payment shrinks as the balance does, which is what makes the facility feel affordable while extending it almost indefinitely.

Where the minimum payment is set below the interest charge, the balance grows even when the borrower pays on time — negative amortisation. Any minimum payment rule should be tested against the highest applicable rate to confirm it cannot produce this.

Utilisation

Utilisation = (Drawn balance ÷ Limit) × 100

Utilisation carries different meaning depending on where it settles:

• Consistently low — the limit is larger than the need. Fine for the borrower, poor return for the lender on capital held against the commitment.
• Fluctuating across the range — the facility is doing its job. Working capital rises and falls, and so does the balance.
• Consistently at or near the limit — the facility has become term debt. The borrower is not funding a cycle, they are funding a permanent hole in working capital, and the revolving structure is hiding it.

The third pattern is the single most useful signal a revolving book produces. It usually precedes distress by many months, it is visible in data the lender already holds, and it is missed by monitoring that only tracks arrears — because a borrower permanently at the limit may never miss a payment.

Clean-down and evergreening

A clean-down or rest requirement obliges the borrower to reduce the facility to zero, or below a stated level, for a continuous period each year — commonly 14 to 30 consecutive days. Its purpose is diagnostic rather than punitive. A genuine working capital facility self-liquidates as the trading cycle completes; a facility funding losses cannot be cleaned down at all. The borrower who requests a waiver of the clean-down is telling the lender something important.

Evergreening is the failure this guards against: rolling a facility that should have been repaid, sometimes increasing the limit to cover the interest, so that an exposure which has effectively defaulted continues to look current. It understates arrears, delays provisioning, and converts a problem that was manageable at 500,000 into one that is not at 900,000.

The markers are recognisable. Utilisation at or near 100% for consecutive review periods. Limit increases that coincide with interest falling due. Clean-downs waived repeatedly. Repayments funded by drawings on another facility. Renewal approved without fresh financials.

What revolving credit demands from a lending operation

Revolving facilities are materially harder to administer than term loans, and lenders that add them to a term book frequently find their processes do not fit.

No schedule to work from. There is no amortisation table, so the interest calculation must run off the actual daily balance. Monthly accrual on an average or period-end balance overcharges or undercharges every borrower every month, and the errors are hard to explain when queried.

Arrears must be defined differently. A term loan is in arrears when an instalment is missed. A revolving facility can be in default through a missed minimum payment, a balance above the limit, an expired facility that was never renewed, or a breached borrowing base — none of which look like a missed instalment. Aging buckets and portfolio at risk both require a stated convention for revolving exposures, or the portfolio metrics silently exclude them.

Limits need managing as objects in their own right. Grant, review date, expiry, temporary increase, permanent increase, reduction, suspension, cancellation — each with its own authority level and audit trail.

Undrawn commitments are exposure. Committed but undrawn amounts carry risk and, under most prudential frameworks, attract a capital charge and a provision. Reporting that counts only drawn balances understates the lender's position.

Payment allocation still applies. Fees, interest and principal are settled in a defined order, exactly as in term lending — see allocation waterfall — but the calculation runs against a moving balance rather than a scheduled one.

Where lines of credit go wrong

Structural mismatch. A revolving facility used to fund a fixed asset. The asset generates returns over years; the facility is repayable on demand. The mismatch surfaces at review.

The limit set to the borrower's ask. Limits should be sized to the working capital cycle — the gap between paying suppliers and being paid by customers — not to what the borrower would like to have available.

No clean-down, or a waived one. Removes the only routine test of whether the facility is self-liquidating.

Monitoring by arrears alone. A fully drawn, never-late facility looks perfect in an arrears report and may be the worst exposure on the book.

Renewal by default. Rolling limits annually without fresh financials, a bureau check or a look at utilisation converts an assessed facility into an unassessed one over a few cycles.

Minimum payments that barely cover interest. Produces borrowers who pay for years and owe almost as much at the end.

Undrawn limits ignored in aggregate. A lender with 40 million drawn and 25 million committed-undrawn has 65 million of exposure, and liquidity risk if a large share is drawn at once.