Evergreen Loan

Loans that do not have a fixed period over which the principal on the loan must be repaid

Also known as "revolving" or "standing loans," evergreen 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.

Evergreen loan

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, thus the term evergreen. 

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. 

Evergreen loan

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. 

This 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 the revolving loans is very different. 

Loan agreement

After applying for revolving loans, there is first a need to examine 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. 

Loan

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. 

Renewing Evergreen Loans

While evergreen loans are normally indefinite in their 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. 

Credit report

 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 in which the lender analyzes whether the borrower has been paying off the loan regularly throughout the year. 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. 

Payments

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. 

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. 

Line of credit

 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. 

Examples

Example

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 credit worthiness, credit rating, debt history, etc. If approved, the lender would provide a maximum credit limit to the borrower. 

The borrower can make payments using the card 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 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, then the available balance on the credit card increases by $500, which X can use again. 

Overdraft

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 entirely depends on them.

Loan Denied

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. 

Interest

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 might pressure 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

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.

Instalment loan

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.

Key Takeaways
  • These loans are also known as "revolving" or "standing loans". 
  • They are loans where the borrower can borrow funds up to the maximum credit limit set by the lender. The borrower can then pay back the amounts according to their capabilities, and as the borrower pays back the debt, the funds become accessible again. 
  • This process can go on indefinitely or till the validity of the contract expires unless the lender feels that the borrower will not be able to pay back the amount and terminates the contract due to poor credit ratings. 
  • The renewal being denied is usually unlikely unless the borrower fails to pay the minimum required amounts or faces extreme financial difficulties.
  • Credit cards and current accounts' overdraft facilities are examples of these loans.
  • These loans can help support a company's working capital requirements. 
  • They, however, can often be costly with a high-interest rate due to the default risk the lender takes on.

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Researched and Authored by Soumil De | LinkedIn

Reviewed and Edited by Hongmo Liu | LinkedIn

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