Over advances: Overview, definition, and example
What are over advances?
Over advances refer to loan amounts advanced by a lender to a borrower that exceed the agreed-upon borrowing base or credit limit under a lending agreement. These excess advances typically occur in asset-based lending, where the loan amount is tied to the value of collateral, such as accounts receivable or inventory. Lenders may allow over advances under specific conditions but often impose higher interest rates, fees, or stricter repayment terms.
For example, if a business has a credit limit of $500,000 based on its receivables but the lender advances $550,000, the extra $50,000 is considered an overadvance.
Why are overadvances important?
Over advances are important because they provide businesses with additional short-term liquidity when needed, but they also present financial and operational risks. Lenders may allow over advances in emergencies or under temporary agreements, but frequent reliance on them can signal financial instability.
For lenders, controlling over advances helps mitigate risk and ensures borrowers do not exceed sustainable credit levels. Over advances are often subject to strict repayment requirements to prevent long-term financial strain on both parties.
Understanding over advances through an example
Imagine a retail company has a revolving line of credit tied to its inventory value. The agreement allows the company to borrow up to 70% of its eligible inventory value, which amounts to $1 million. If the lender advances $1.2 million, the additional $200,000 is classified as an overadvance. The lender may charge a penalty interest rate and require immediate repayment to bring the loan back within the agreed borrowing base.
In another scenario, a manufacturer with a credit facility based on accounts receivable experiences a seasonal cash flow shortage. The lender temporarily approves an overadvance to help the company meet payroll, requiring repayment within 30 days to avoid default.
Example of an overadvances clause
Here’s how an over advances clause might appear in a loan agreement:
“The Lender, at its sole discretion, may permit advances in excess of the Borrowing Base (‘Overadvances’). Such Over advances shall be payable on demand and shall bear interest at the Overadvance Rate specified in this Agreement. The Lender reserves the right to decline any further advances until the Borrower’s outstanding balance is within the approved credit limit.”
Conclusion
Over advances provide businesses with temporary access to extra credit beyond their borrowing base, often under stricter repayment terms. While they can be useful for short-term financial needs, over advances carry higher risks and costs for both borrowers and lenders. Proper financial planning and credit management help businesses avoid excessive reliance on over advances.
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.