What Is a Clean-Up Requirement?
A clean-up requirement is a condition that is often written into the contracts of annually renewable lines of credit or revolving lines of credit. Clean-ups aren't usually required onsecured creditcards orlines.
A clean-up requirement clause may 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.
Key Takeaways
- A clean-up requirement is a condition that is often written into the contracts of annually renewable lines of credit.
- Clean-up requirements require that a business periodically pay down its balance for a certain period of time before accessing it's line of credit.
- While they are becoming less common, clean-up requirements were once frequently placed in contracts before extending a line of credit to a business.
- The main intention of a clean-up requirement is to ensure that businesses are not using credit lines instead of income to pay operating expenses.
How a Clean-Up Requirement Works
The intent of a clean-up requirement clause is typically to ensure that businesses do not start relying too heavily on a line of credit they establish and that their revenue from sales is the primary source of income. A clean-up requirement is sometimes referred to as an "annual clean-up."
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 until it maxes out all available credit options.
Note
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 certain amount of time, such as 30, 60, or 90 consecutive days during a 12-month period.
Other Potential Clean-Up Requirements Rules
Other stipulations of clean-up periods can include customers not incurring overdrafts for 30 or 60 days each year they use a revolving lineof 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 principal 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.
Loans Without Clean-Up Requirements
However, clean-up requirements are becoming less common. Many banking institutions do not see the need to make their customers "clean up" their lines of credit as long as clients' accounts are up-to-date and principal andinterest payments are received on time.
Increasingly, lenders are offering unsecured loans without clean-up requirements on loans that previously typically would have included them, such as commercial access lines of credit.
Do Clean-Up Requirements Apply to Secured Lines of Credit?
Clean-up requirements generally do not apply to secured lines of credit as the lender already has the security of collateral, or an asset that it can seize to help it recoup any losses in the event a borrower fails to pay.
What Is a 30-Day Clean-Up Period in Finance?
A 30-day clean-up period is when a lender requires a borrower to pay their outstanding debt and then carry no balance for 30 days before they can use their revolving credit line. This practice can be used, for example, in financing commercial construction.
What Are Downsides to Clean-Up Periods for Borrowers?
A business that carries a clean-up clause on its revolving loan will have to periodically keep that balance at zero for a certain period of time. That means, money that could be used to help grow the business will have to go to pay down any outstanding debt on the loan, which would slow business growth.
The Bottom Line
A clean-up requirement, while less commonly used nowadays, is a clause in a credit contract that helps the lender ensure the borrower can meet their obligations and is not too dependent on the financing. For revolving lines of credit, a clean-up credit can require that the borrower periodically settle the outstanding debt before they continue to use their line of credit or revolving loan. This way, the lender ensures the borrower isn't relying on the financing permanently.
