A loan that never goes away may seem like a nightmare, but it can be quite beneficial if used properly. These types of loans are known as “evergreen.” While not everyone will qualify for this type of loan, a borrower who shows consistently strong financial performance can renew his loan every year until it is no longer needed
An evergreen loan is also known as a revolving loan. This means you can use it, pay the money back and use it again. The loan is reviewed by the lender annually. If you meet the criteria for renewal, the loan is continued. This can go on indefinitely until you or the bank decide to cancel the loan. As long as you pay and can support the loan, the bank won’t take any action to close it.
The most common type of evergreen loan is a revolving line of credit. These are usually granted to businesses for working capital reasons. Working capital describes money used to support day-to-day functions of a business. For example, a business owner might need money to cover expenses while waiting for payments from clients to come in. He will use the line of credit to get the money he needs to run his business and pay that money back when he is paid by his client. Another common type of evergreen loan is a letter of credit. In this case, no money changes hands. The bank simply provides a letter to a beneficiary on behalf of a client. The letter states that the bank will guarantee payment of its client’s obligations in the event the client can’t. This letter can be renewed indefinitely until the beneficiary no longer requires it.
When it comes time to renew an evergreen loan, the bank looks at several criteria. First, it wants to see that the borrower can still support the debt. The borrower provides updated financial statements to the bank. The bank wants to see that the borrower’s income significantly exceeds his debt. The lender also evaluates any collateral to see if it holds sufficient value to support the loan. Sometimes, if a borrower is very strong financially, collateral may not be a consideration. The lender also wants to see that the balance has been reduced occasionally instead of hovering near the top of the credit line.
Evergreen loans can be problematic if a borrower’s financial condition deteriorates. If the line does not have a balance, the bank can simply opt not to renew it. If it does have a balance, the bank will “term out” the loan, meaning it will take the balance and amortize it. It will convert the payments from interest only to monthly principal and interest over a term, usually three to five years. The bank may also opt to term out the loan if the borrow fully extends the line and leaves it there. If a line is maxed out for more than a year with no principal reductions, it is likely that the borrower is not in a position to pay back the balance. At this point, the bank will want an exit strategy as opposed to keeping the loan evergreen.