What Is an Annual Clean-Up?
An annual clean-up is a banking practice that requires a borrower to pay off all balances of any renewable lines of credit and keep them at zero for 30 to 60 days or even 90 consecutive days during a 12 month period. Although the annual clean-up is a long-time tradition, it's becoming less common nowadays. Clean-ups aren't usually required on secured credit cards or lines.
Annual clean-up is also known as the clean-up requirement.
- An annual-clean up is a banking practice that requires a borrower to pay off all balances on any renewable lines of credit and keep them at zero for a specified period of time.
- The time frame that a borrower must keep balances at zero usually ranges from 30 to 60 days and can even stretch to 90.
- The purpose of an annual clean-up is to reduce the risk exposure of the lender as well as for the borrower to demonstrate that it does not solely rely on debt to run its business.
- Short-term loans, also known as lines of credit, are typically subject to an annual-clean up as opposed to long-term loans.
- Annual clean-ups are not as common as they once were as banks rarely require borrowers to keep balances at zero, particularly if the account is in good standing.
Understanding Annual Clean-Ups
The annual clean-up usually takes place when the customer is flush with cash, usually after a peak sales period when receivables have mostly been collected and cash needs for replenishing inventory are low. The clean-up shows that credit lines are being used only during periods of peak cash requirements and are not needed for the normal financing of the business.
Clean-up requirements are not required by most lenders. Many of today's banking institutions do not ask customers to "clean up" lines of credit if clients' accounts are up-to-date and principal and interest payments are paid on time.
There can be other stipulations during an annual clean-up period, such as not incurring overdrafts for 30 or 60 days for each year that the customer uses their revolving line of credit.
Another requirement might be that an outstanding balance stays within a specified limit. For example, a customer may be held under a constraint that for 60 days in a 12-month period, their principal balance cannot go past a set percentage of their full line of credit. These requirements would force the customer to either pay down the balance or restrict the use of their line of credit.
Benefits of an Annual Clean-Up
Banks that require annual clean-ups, or those that did, do so because it reduces their risk exposure. If a borrower is constantly drawing on their line of credit, building up debt, it makes it harder for them to pay it back. Or it takes longer to pay it back. This leaves the lender, the bank, exposed to credit risk in that the borrower may default on their loan and not pay back the outstanding amount.
Annual clean-ups also demonstrate that a borrower isn't solely depending on its debt to run its business. Rather, it shows that the business's operations are run well and that for the most part, it can rely on cash from operations to continue running its business and only draw on its debt when actually needed.
Types of Loans
When a business applies for a loan, it usually receives one of two types: a line of credit or a term loan. A line of credit is a short-term loan with a maturity of 12 months or less. A term loan is a long-term loan with maturities typically between three to five years.
More often than not, an annual clean-up is applied to a short-term loan; the line of credit. In these types of loans, interest is due monthly and principal at discretion, with the full amount due at maturity. An annual clean-up would require that the borrower would pay the balance down to zero for the stipulated amount, most often 30 days.
After that, the borrower can borrow up to their limit as they please and pay down the amount whenever they are able.