A term loan's cost is set at closing. A revolver's cost is set by how you use it. Two businesses can sign identical facilities (same limit, same rate, same fee schedule) and end the year having paid effective rates that differ by ten points or more, purely because one averaged seventy percent utilization and the other averaged fifteen. Nothing in the term sheet tells you this. The arithmetic does.
That makes a revolver the one commercial facility where understanding the mechanics changes what you pay. This is the plumbing: how interest accrues, what the three components of price actually are, why fixed fees dominate at low utilization, what a cleanup requirement is for, and what happens when a line quietly stops revolving and becomes term debt that nobody structured.
How interest actually accrues
Interest on a revolver accrues daily on the balance outstanding that day, then bills monthly. Draw $200,000 on the eighth and repay it on the twenty-second and you paid for fourteen days, not a month. That is the entire benefit of the structure, and it is why sweeping idle cash against the balance is the highest-return treasury habit available to a business that carries one.
Two details in the accrual convention are worth checking in the agreement. First, whether interest is computed on a 360-day or 365-day basis; a rate quoted on a 360-day year over 365 actual days costs slightly more than the quoted number suggests. Second, whether the rate floats over a published index, and whether the facility carries a floor beneath which the rate cannot fall. Neither detail is dramatic on its own, and both are easy to confirm before you sign.
The three components of price
Every revolver charges in three ways, and only the first is what most people mean by rate.
- Interest on the drawn balance. Accrues daily, varies with utilization, and is the only component that rewards you for repaying.
- The unused-line or commitment fee. A smaller percentage charged on the undrawn portion, compensating the lender for reserving capital it is obligated to advance. It penalizes an oversized limit.
- Fixed fees. Origination or closing at the start, annual renewal each year, and on asset-based facilities, field examination, collateral monitoring and sometimes wire or draw fees. These do not vary with usage at all.
The third bucket is the one that distorts effective cost, because it is a fixed charge divided by a variable balance. The less you use the line, the more each borrowed dollar carries of that fixed cost.
The math of average utilization
Take a $500,000 facility priced at an illustrative 10.5 percent on drawn balances, with a 0.375 percent unused-line fee and a $5,000 annual fee. The effective cost of the money you actually borrowed depends almost entirely on your average balance across the year.
| Average balance | Interest | Unused fee | Annual fee | Total cost | Effective rate on borrowed funds |
|---|---|---|---|---|---|
| $50,000 (10%) | $5,250 | $1,688 | $5,000 | $11,938 | ~23.9% |
| $100,000 (20%) | $10,500 | $1,500 | $5,000 | $17,000 | ~17.0% |
| $250,000 (50%) | $26,250 | $938 | $5,000 | $32,188 | ~12.9% |
| $350,000 (70%) | $36,750 | $563 | $5,000 | $42,313 | ~12.1% |
| $450,000 (90%) | $47,250 | $188 | $5,000 | $52,438 | ~11.7% |
The stated rate is 10.5 percent in every row. The effective cost ranges from roughly 11.7 percent to nearly 24 percent. Nothing changed except behavior.
The cleanup requirement
Many revolvers include a cleanup, rest or annual-out provision requiring the balance to sit at or near zero for a defined stretch each year. The specific duration varies by lender and facility, but the intent is constant: prove that the line funds a cycle that completes rather than a deficit that persists.
Treat the requirement as a diagnostic rather than an inconvenience. If you can rest the line comfortably, the facility is doing its job. If resting it requires borrowing elsewhere or stretching payables to the point of damaging vendor relationships, the underlying need is not seasonal: it is permanent, and it needs a different structure.
When a revolver stops revolving
The most expensive thing that happens to a working-capital line is that it hardens. The balance drifts up, never comes back down, and after eighteen months there is a permanent core that behaves like term debt but carries floating rate, annual renewal risk and no amortization schedule. From the lender's side this reads as one of three things: the business is funding losses, funding fixed assets, or has a working-capital cycle that has quietly lengthened. All three change the review.
The usual remedy is a term-out: converting the hardened core into an amortizing term loan and leaving the revolver for the fluctuating portion. Some agreements include a term-out option contractually; more often it is negotiated at renewal. Either way, initiating that conversation yourself is a much better position than having a reviewer initiate it, because you keep control of the amortization period and the timing.
Sweeps, lockboxes and dominion of funds
On asset-based facilities, cash management is part of the structure. A lockbox directs customer payments to an account the lender controls; those collections then reduce the loan balance and availability is redrawn as needed. Under full dominion, that flow is automatic and continuous. Under springing dominion, it activates only if a trigger (typically a covenant breach or an availability threshold) is hit.
Operators tend to resent dominion arrangements and then discover they lower interest cost, because every collected dollar reduces the balance the same day rather than sitting idle in an operating account until someone remembers to sweep it. The real considerations are administrative: what happens if the lender misapplies a payment, how quickly availability is restored after a collection posts, and how much notice you get before springing dominion activates. Those are worth negotiating; the concept itself usually is not.
Reading the fee schedule before you sign
Fee schedules are where the difference between two similar-looking facilities lives. The exercise takes twenty minutes: list every charge, mark whether it is one-time, annual or per-event, and model the total against your expected average balance rather than against the limit.
Line-agreement review checklist
- Interest basis: 360 or 365 days, floating or fixed, and whether a floor applies.
- Unused-line or commitment fee: the percentage and whether it is charged on the full undrawn amount.
- Origination or closing fee, and whether it recurs on renewal.
- Annual renewal fee and the notice period before renewal or non-renewal.
- Field examination and collateral monitoring costs, including expected frequency.
- Cleanup or resting requirement: duration, timing and how compliance is measured.
- Borrowing base reporting cadence and the certificate deadline each period.
- Cash management terms: lockbox, full or springing dominion, and the triggers.
- Financial covenants, testing frequency and the definitions behind each term.
- Default rate: how many points it adds and what events trigger it.
- Termination and prepayment provisions if you want to exit early or refinance.
Using the facility well
Three habits separate operators who get value from a revolver from those who just carry one. Sweep idle cash against the balance daily or weekly rather than letting it sit; on a $200,000 average balance, ten days of unnecessary borrowing a month costs roughly $5,800 a year at an illustrative 10.5 percent. Draw for specific, self-liquidating purposes so that each draw has a repayment source attached. And watch the core balance monthly, so that hardening is something you notice at month four rather than at renewal.
Is it bad to carry a balance on a line of credit continuously?
A balance that never touches zero tells a reviewer the line is funding something permanent, which affects renewal, sizing and sometimes pricing. Steady usage inside a visible cycle is fine; a floor that only rises is the problem. The distinction a lender draws is between a balance that fluctuates and one that has become structural.
How is the unused-line fee calculated?
Typically as an annual percentage applied to the average undrawn portion over the billing period, then billed monthly or quarterly. Some agreements charge on the full commitment regardless of usage, which is a materially different deal, so read the definition rather than assuming. On a large, lightly used facility this fee can exceed the interest you pay.
Does paying the line down to zero every month save money?
It saves interest for every day the balance is lower, since accrual is daily. It does not usually change fees, which are fixed or based on the undrawn amount. The real caution is not paying it down to zero using cash you need next week and then redrawing, which accomplishes nothing except a slightly worse liquidity picture on statement day.
What is a default rate and when does it apply?
It is an elevated interest rate the agreement permits the lender to charge after a default, often several percentage points above the ordinary rate, and it can apply to the whole balance. The important detail is what triggers it, since many agreements allow it on covenant or reporting defaults, not just missed payments. The specific increment and the triggers vary by agreement.
Can my lender reduce the limit mid-term?
It depends on whether the facility is committed or uncommitted, and on the borrowing base. A demand or uncommitted line can generally be reduced or called under the terms of the agreement. Even on a committed facility, availability moves with the borrowing base, so the practical limit changes monthly without any decision being made. Read the commitment language before assuming the stated limit is committed capacity.
Should I take a bigger limit than I need in case something comes up?
Usually not. Excess capacity costs unused-line fees and fixed charges, and many lenders test your coverage as if the line were fully drawn, which reduces what you can borrow elsewhere. A limit matched to a documented peak, with a clear path to request an increase, is generally the better structure.
How do I compare a revolver against a short-term advance?
Convert both to an annualized cost on the average balance you will actually carry. Advances with daily or weekly remittance repay principal so fast that their annualized cost and their annualized debt service are both far higher than the headline factor suggests. A revolver at an illustrative 12 percent used at fifty percent utilization is a different order of expense, and it does not consume coverage the same way.
Where to start
Pull twelve months of line statements and compute two numbers: your average daily balance across the year, and the highest monthly low. The first tells you the effective rate you are actually paying once fees are spread across it. The second tells you whether you are carrying term debt inside a revolving facility. Those two figures will tell you more about your working-capital structure than the term sheet ever did.
Qualified Commercial Underwriting Desk
Credit and capital markets
The Qualified Commercial underwriting desk reviews commercial real estate, dealer and Main Street files daily. The Academy is written from that work (how files are actually read, priced and declined) rather than from a rate sheet.
Educational content only. Nothing here is a commitment to lend, an offer of credit, or tax, legal or accounting advice. Program terms, timelines and thresholds vary by lender, file and market conditions, and any figures shown are illustrative.