What Is Clean-Up Requirement
A clean-up requirement is a condition that is often written into the contracts of annually renewable lines of credit. Clean-up requirements can require the borrower to pay off any outstanding balance on the line of credit and then cease to use the line of credit for a specified period of time. Clean-up requirements are usually implemented as a means of preventing borrowers from using lines of credit as ongoing permanent financing.
- A clean-up requirement stipulates that a borrower must pay off all debt for a period of time before opening a new line of credit.
- They are not common anymore but were once frequently placed in contracts before extending a line of credit to a business.
- The main intention of a clean-up requirement was to ensure that businesses were not using credit lines instead of income to pay operating expenses.
Understanding Clean-Up Requirement
Clean-up requirements are becoming less common in banking today. Some lenders do not see the need to make their customers "clean up" their lines of credit as long as principal and interest payments are received on time. This requirement is also known as "annual clean-up."
The intent of a clean-up requirement clause is typically to ensure that businesses do not overly rely on the line of credit they establish and that their revenue from sales is the primary source of income. Without such restrictions, it is plausible that a business might pay its regular, recurring operating costs such as payroll, rent, or utilities through a line of credit rather than from generated earnings. Such reliance on a line of credit could indicate the company is not generating enough income to sustain itself or pay off its debt. This could lead to a cycle of a business taking out more and more lines of credit to pay its bills, instead of generating income to do so, until such time as it has maxed out all available credit options.
The intent of a clean-up requirement clause is typically to ensure that businesses do not overly rely on the line of credit they establish and that their revenue from sales is the primary source of income.
The terms of a clean-up requirement may call for the borrower to clear the balance on its line of credit and keep it at zero for 90 consecutive days during a 12-month period.
Other stipulations of clean-up periods can include customers not incurring overdrafts for 30 or 60 days each year they use a revolving line of credit. There might also be a requirement that the amount of money that remains outstanding from the line of credit be kept within certain limits. For example, the customer may be under a constraint that for at least 30 days of the 12-month period, the principle balance cannot exceed a set percentage of the full line of credit. This would force the borrower to either restrict the use of the credit line or to pay down the balance to keep it within those parameters.
Such requirements can help financial institutions reduce their exposure by offering some guarantee that their customers are not amassing debts they cannot repay.