Incremental loans: Overview, definition, and example
What are incremental loans?
Incremental loans are a type of loan that allows the borrower to borrow additional funds on top of an existing loan, typically under the same loan agreement or credit facility. These additional loans, or "increments," are often used to support ongoing business needs or projects, and they can be drawn down in stages over time as needed. Incremental loans provide flexibility for businesses to access capital without needing to renegotiate a new loan every time additional funds are required.
For example, a company may secure a large line of credit for expansion and then, as its needs grow, borrow more funds through incremental loans rather than applying for a new loan.
Why are incremental loans important?
Incremental loans are important because they offer businesses the ability to access additional funds as their needs evolve without the administrative burden of negotiating separate loans each time. This flexibility can be crucial for businesses experiencing fluctuating cash flow or those undertaking long-term projects with unpredictable funding requirements. Incremental loans can also help businesses avoid the costs and complexities associated with applying for multiple loans.
For lenders, offering incremental loans can provide the benefit of maintaining an ongoing relationship with the borrower while receiving interest on the additional funds as they are borrowed.
Understanding incremental loans through an example
Imagine a company takes out a $1 million loan to finance the construction of a new factory. Initially, they only need $500,000 to start the project. However, as construction progresses, they require more funds to complete the work. Instead of applying for a separate loan, they utilize the incremental loan option, which allows them to borrow additional amounts up to the $1 million total, as needed.
In another example, a business may take out a credit facility with a $500,000 limit, and over time, as they expand and their financing needs grow, they can draw on incremental loans to access more funds, all under the same facility agreement.
An example of an incremental loan clause
Here’s how an incremental loan clause might look in a loan agreement:
“The Borrower shall have the option to request additional loans under this Agreement, in increments of up to [Insert Amount], subject to the terms and conditions set forth herein, provided that the total amount of loans shall not exceed [Insert Maximum Limit].”
Conclusion
Incremental loans are a flexible financial tool that allows businesses to access additional capital over time, under the same loan agreement or credit facility. This option provides businesses with the ability to scale their borrowing to meet evolving needs without the complexity of negotiating new loans. For lenders, offering incremental loans can strengthen relationships with borrowers and ensure continuous revenue from interest. Clearly defining terms for incremental loans in agreements ensures that both parties understand the conditions and limitations of accessing additional funds.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.