Evergreen Loan
Loans that do not have a fixed period over which the principal on the loan must be repaid
What is an Evergreen Loan?
Evergreen Loans, also known as “revolving” or “standing loans,” are loans that do not have a fixed period over which the principal on the loan must be repaid. The borrower is only required to make interest payments throughout the life of the loan. The word “evergreen” denotes that the loan can be accessed repeatedly.
These revolving loans are mainly offered as a line of credit. The borrower can borrow funds up to the maximum credit limit set by the lender and then pay back the amounts at set intervals, for example, on a monthly basis.
When the payments are made, the funds become accessible again for borrowing.
This process can continue indefinitely during the contract period, i.e., till the contract's validity expires, and the borrower can borrow the funds as many times as they wish.
Evergreen loans are available through a variety of banking instruments and can take many different forms. One popular evergreen loan product is the credit card. Another one is checking account overdraft.
Evergreen loans are a convenient form of credit, because they allow borrowers to access funds without having to apply for a new loan each time they do. Both individuals and corporations are able to take advantage of them.
More often than not, as long as the borrower makes the minimum payments regularly, the lender keeps renewing the loan indefinitely.
However, the lender must review whether the borrower meets the qualifications of the loan before the initial contract signing and during the annual renewals.
This revolving credit contrasts with non-revolving credit. The latter loan type gives the borrower their principal sum upon loan approval. After that, until the loan is repaid in full, the borrower is required to make regular payments. After the borrower repays the loan, the account is closed, and the lending arrangement is over.
Key Takeaways
- Evergreen Loans are loans without a fixed repayment period. Borrowers only make interest payments, with the principal accessible for borrowing repeatedly.
- Borrowers can repeatedly withdraw and repay funds within the credit limit, maintaining indefinite accessibility unless the lender terminates the loan due to poor credit or failure to meet payment obligations.
- Annual reviews of financial statements, collateral evaluation, and payment consistency are typical renewal criteria for evergreen loans, ensuring the borrower's financial stability.
- Evergreen loans offer flexibility for individuals and businesses, supporting ongoing working capital needs and eliminating the need for frequent loan applications.
How Do Evergreen Loans Work?
In a regular loan, once the lender approves the loan amount, they would issue a principal amount to the borrower, who then is required to pay back the loan over-scheduled outlays in the form of an installment throughout the life of the loan.
The installment amount includes both the principal and the interest. Once the entire loan is paid off, normally, the contract is over, and the lending relationship ends. Comparatively, the working of revolving loans is very different and follows a common pattern.
- When applying for a revolving loan, the lender first examines the borrower's qualifications by analyzing their income, financial statements, collateral, etc. Once qualified, borrowers are provided with an indefinite line of credit.
- During the contract period, the borrower can withdraw money up to the maximum limit on the credit and pay back the amount as many times as they wish. When they withdraw money, the available credit decreases. Conversely, when they pay it back, the money becomes accessible again, and the borrower can withdraw it again.
- The lenders usually charge a higher interest rate in such cases due to the increased risk. There may also be additional charges if the borrower does not meet the minimum payment requirements or if they further overdraw the amounts.
- One can choose as and when to repay the amounts as well as how much of a balance they should be paying back, as long as they maintain their minimum payment requirements. This removes the need to apply for a loan again and again, allowing the borrower to keep using the same line of credit indefinitely.
This loan can be beneficial for companies that need more working capital as it allows them to keep drawing funds to finance everyday needs while also paying back as and when they can.
Renewal Criteria for an Evergreen Loan
While evergreen loans are normally indefinite in duration, their contracts need to be reviewed by the lender annually to ensure that the borrower still meets the qualifications and can pay back the minimum required amount.
Some of these renewal criteria are:
1. Financial Statements
The first and foremost check is always of financial statements. The main aim of checking these statements is to look at the past and present debts of the borrower and examine whether the debts were paid on time and whether the borrower's income is enough to cover the debts.
2. Collateral
For borrowers with lower incomes, collateral is often required to secure such a loan. The main aim of assessing the borrower's collateral is to check whether the collateral holds enough value to hedge against debts if the borrower defaults.
In case the borrower defaults, the lender would then be able to use the collateral to recover their losses.
3. Consistency of Payments
This is perhaps the most critical criterion. If the borrower often borrows close to the maximum credit limit and fails to make the minimum payments regularly, the lender may choose to discontinue the loan.
Uses of Evergreen Loans
Evergreen or revolving loans give a lot of flexibility to borrowers. As long as they keep making the minimum payments and have a good enough financial position to qualify for the loans, they can withdraw and pay back the money according to their needs.
Borrowers can borrow the money anytime in the contract period and can pay back the amount whenever they can, as once they pay back the money, the amount is again available to be withdrawn. This process removes the hassle for businesses and individuals to apply for loans repetitively.
Revolving loans can be a great lifeline for businesses facing a cash crunch and needing working capital. They enable businesses to borrow money for expenses and fund big orders.
These loans are also useful in personal finance in the form of credit cards and bank overdrafts. For personal loans, the basis for qualification is often the individual's credit scores.
The Most Common Types of Evergreen Loans
There are two main types of evergreen loans: a revolving line of credit (LOC) and a letter of credit.
1. Revolving Line of Credit (LOC)
LOC is the most common type of evergreen loan. It is given to businesses that are in need of working capital. The borrower can borrow funds up to the maximum credit limit.
When the borrower keeps paying back the amount, the funds become available again. Companies can borrow funds to finance operations and pay back the money when the payments roll in.
2. Evergreen Letter
Also called an evergreen note or a letter of credit, it helps the borrower get this type of loan from another entity. The letter works as a guarantee to the actual lender that the particular bank would satisfy the portion of the loan obligation that the borrower can not satisfy.
This letter can help the actual lender consider the contract, and just like the line of credit can be renewed indefinitely.
Evergreen Loan Examples
Credit cards and overdrafts on checking bank accounts are some of the most common examples of such a loan.
A credit card is only approved after an extensive analysis of a person's creditworthiness, credit rating, debt history, etc. If approved, the lender will provide a maximum credit limit to the borrower.
The borrower can use the card to pay for things up to the maximum credit limit. At the end of the month, the borrower would then have to pay back the card balance or the minimum monthly payment, which includes the principal and interest.
This then increases the available funds, which the borrower can use again.
For example, if the maximum limit is $1000 and X uses his entire balance to buy raw materials for his business. At the end of the month, he makes the minimum payment of $500, and then the available balance on the credit card increases by $500, which X can use again.
X can use the credit line as much as he wants within the limit of $1000 and can pay back the amount as and when it is appropriate for him as long as he meets the minimum payment limit.
Similarly, an overdraft facility that is provided with a current balance can be another example of such a loan.
Potential Problems With Evergreen Loans
While these loans can be advantageous in many situations, they can be problematic if one depends entirely on them.
An evergreen loan may not always last indefinitely. Suppose, during the annual review of the borrower for loan renewal, it is found that the borrower is not in a very sound position financially. In that case, the lender may terminate the contract.
This can also occur if it is found that the borrower maxed out on the credit limit very frequently and either did not pay or delayed the payment of the interest or the minimum payment due.
The lender may conclude that the borrower will not be able to repay the loan and may end the lending relationship.
This can severely impact someone who is extremely dependent on such credit facilities. For example, a business that is facing a cash crunch may struggle with a lack of working capital if it does not have access to such credit lines.
Additionally, these loans often have very high-interest rates due to the huge risks lenders often face. Interest rates can be as high as 18%, which can be onerous on the borrower.
Lenders like big banks often facilitate the evergreening of loans by giving further loans to a firm on the verge of default. Consequently, defaults in the short run decrease; however, in the long run, the evergreening of loans can lead to an explosion in the number of defaults.
To avoid being detected in such practices, banks often use shell corporations to complete the evergreening issue, which is often called indirect evergreening. This process can be extremely dangerous for banks in the long run, as seen in the case of IndusInd Bank.
Alternatives to Evergreen Loans
If an evergreen loan is discontinued, or if a business does not want to pay such high-interest rates, are there any alternatives to such loans?
An individual or a business can apply for a non-revolving loan or an installment loan. These regular loans provide the loan in a lump sum manner. The borrower then has to pay it off in installments periodically, which includes the principal amount and the interest.
The amount of money paid back does not become available for use yet again. Thus, these loans may not be appropriate to finance the ongoing working capital needs. However, the funds are more effective for one-time payments like buying a factory or a house.
Non-revolving and installment loans have a lower interest rate than revolving loans.
Evergreen Loan FAQs
A revolving loan facility is a type of credit provided by a financial institution that allows the borrower to withdraw funds, repay the loan, then withdraw funds again.
The minimum monthly payment is the lowest amount a borrower must pay on their revolving credit account each month to keep their credit card account in good standing.
It is the very minimum that a consumer must do to avoid late penalties and maintain a positive credit history.
Banks often issue evergreen loans to prevent borrowers from turning into non-performing assets (NPAs). NPAs are loans or advances of which the payment of the principal amount is past due and no interest payments have been made.
These assets are no longer generating income for the banks. To mitigate money loss, banks try to avoid NPAs in the long run. Hence, when they think the borrower is about to default, banks may provide additional loans to the borrower that allow them to revive the loan.
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