How Revolving Loan Funds Work

Revolving loan funds provide continuous access to capital.

A revolving loan fund is a financing mechanism that allows a borrower to use loan proceeds for a variety of projects, or for a variety of purposes on a single project. The borrower takes out money from the loan fund as needed, and repays that money as soon as it becomes available from the project. As long as the borrower replenishes the revolving loan fund, the borrower always has continued access to the money in the fund.

Loan Agreement

A revolving loan fund is a complicated form of loan agreement. Practically speaking, a revolving loan fund works like a series of consecutive loans. The lender places a certain amount of money into the revolving loan fund, and the borrower has the right to access that money for specific purposes and for a specific time frame. Each time the borrower withdraws money from the revolving loan fund, the borrower essentially enters into a new loan agreement under which the borrower promises to repay the money to the loan fund.

Withdrawal

At the outset, the lender will set up certain conditions that the borrower must meet before he can withdraw any money from the revolving loan fund. For example, the borrower may have to submit invoices, receipts, or some other proof that payment has been made for the specified purpose. Additionally, the borrower may have to submit written proof that the borrower will be able to repay the loan funds within the required time frame. For example, the borrower may request money from the revolving loan fund in order to pay off a materials supplier on a construction project, and the borrower will repay the loan fund when the construction project sells after completion.

Purpose

The purpose of a revolving loan fund, especially compared to a traditional single loan agreement, is to establish a system and an account for continuous use by the borrower. The borrower may have a series of projects the lender wishes to finance, and a revolving loan fund provides a simpler option than the lender issuing several different loans to the borrower.

Features

The revolving loan fund works a lot like a typical loan agreement. The amount withdrawn from the loan fund generally carries interest, which means the borrower always has an incentive to pay back the loan fund as soon as possible. The longer the borrower takes to repay the fund, the higher the interest charges the borrower must pay. The loan fund generally carries a late payment penalty just as a standard loan agreement would. The borrower may have to pay an origination or start-up cost for the fund, just like a standard loan. The lender may require some type of collateral as security for the loan fund, such as a deposit account or a piece of real property owned by the borrower. The revolving loan fund will likely have a single stated purpose, such as construction of homes within a specific subdivision, and a definite period of time, such as five years from the date of opening the fund.

References

• "Essentials of Practical Real Estate Law"; Daniel F. Hinkel; 2011)