Costs
Part of Lines of credit: terms to review before signing
What a lines of credit calculator can't price for you
A lines of credit calculator can't price a revolving facility, because the usage assumption is yours. Here are the variables, the formula and the usage test.
Nothing on this page calculates anything, and a lines of credit calculator cannot do it for you either. There is no widget below, and no single total that would be honest to publish either: the cost of a revolving facility turns on an assumption about your own usage, and only you can make it.
What is here is the algebra, and one thing a general calculator cannot give you: a revolving facility has no single cost until you supply an assumption about your own behavior. Write the assumption down first. Everything else follows from it.
What to take away
- A facility's cost depends on a usage pattern you have to assume, so the assumption is the most important input.
- Model the two states separately, then divide the total by what you actually borrowed.
- Test the same facility against a heavier and a lighter pattern before you sign anything.
The assumption, before any arithmetic
Three numbers, from your own records rather than from hope.
The assumption
- d
- Days per year you expect to be drawn
- B
- Average balance during those days
- k
- Number of separate draws that pattern implies
If your agreement carries a clean-up or annual rest provision, d has a ceiling, because the balance must sit at zero for that window. Build the ceiling in now rather than discovering it later.
The variables from the offer
Symbol / What it is
- L
- The limit
- r
- The annual rate applied to the drawn balance
- Y
- The day-count basis your agreement specifies
- u
- The charge on availability, and the base it applies to
- f
- The charge per draw
- S
- Standing charges for a year: maintenance, annual, renewal
Two of those need a question rather than a reading. Ask what Y is, because a year is not always counted the way you would count it. Ask what base u applies to, because a charge on the whole limit and a charge on the unused portion are different amounts.
Y is the day-count basis. Agreements commonly count a year as 360 days and sometimes as 365, and the same nominal rate produces a slightly different interest figure under each. In practice, most business lines of credit use a 360-day year (the banker’s year), but some use 365; confirm which before you enter a number. A calculator that assumes one without asking is close by luck rather than by method.
The four components
The four cost components
- I = r × B × (d ÷ Y)interest on drawn balance
- F = k × fdraw charges
- U = u × baseavailability charge
- Sstanding charges for the year
In prose, the four are interest on the drawn balance, an availability charge on the unused portion of the limit (or on the whole limit, depending on the agreement), a fee for each draw, and a standing annual or maintenance charge. Interest moves with your balance, the availability charge moves with what you leave untouched, the draw fee moves with k, and the standing charge does not move at all.
That is the whole cost. Two of the four accrue whether or not you ever draw, which is the feature that makes a facility unlike any other product on your shelf. The mechanism behind each charge is set out in lines of credit cost.
Turning it into a comparable number
The denominator is the part people get wrong. Do not divide by the limit, and do not divide by B.
What to divide by
Wrong denominator
- Limit L
- No
- Average balance B
- No
- A = B × (d ÷ Y)
- —
- Cost per dollar
- Misleading
Right denominator
- Limit L
- —
- Average balance B
- —
- A = B × (d ÷ Y)
- Yes
- Cost per dollar
- C ÷ A
Average balance across the whole year: A = B times (d divided by Y)
Cost per dollar borrowed, per year: C divided by A
That figure is directly comparable with the annualized cost of capital on any other product, including a term loan, because it answers the same question: what did each dollar you actually had the use of cost you for a year. The general form of the conversion is in application and repayment.
Some people find dollar-days easier: multiply B by d to get expected dollar-days of borrowing, then divide C by that.
The result is the cost of holding one dollar for one day. Keep the useful number in mind when deciding whether to draw on Thursday or wait until Monday.
Run it twice, then find the crossover
A single answer tells you almost nothing, because you chose d and B yourself.
Run a light pattern. Small d, small B. Watch what happens to C divided by A. The standing charges are being spread over very little borrowing, and the result is often many times the quoted rate. That is the true cost of holding a facility you rarely use, and it is a real cost even though it feels like insurance.
Run a heavy pattern. Large d, large B. If the facility only looks reasonable when you are drawn almost continuously, it is not standing capacity. It is a term loan with extra steps, and you should price one beside it.
Find the crossover. Increase d in your sheet until C divided by A matches what a term loan for roughly B would cost per dollar per year. That level of use is your break-even. Below it, the facility is buying flexibility at a premium you can now name. Above it, you are paying revolving pricing for something permanent. There is no formula for this point, and there does not need to be: change one cell until the two figures meet.
Which input to negotiate
Change one variable at a time and watch C divided by A move.
- If k is large, the draw charge is probably doing more damage than the rate. Ask about it before you ask about the rate.
- If d is small, the standing charges dominate and the useful question is whether a smaller limit carries a smaller charge.
- If B is large and d is large, interest dominates and the rate is worth arguing about.
- If a minimum charge applies, check whether your light pattern even reaches it. If it does not, your real cost is the minimum, whatever the algebra says.
Negotiate whatever moves the number. Ignore whatever does not. The structural background to the two states is in lines of credit.
Where to check anything specific
Every value above comes from an offer in front of you and from your own records. Rates, fees and charges change constantly and vary between institutions. For a business line of credit there is no consumer-style cost disclosure to lean on: the federal Truth in Lending Act and Regulation Z, which require the cost figures on consumer credit, generally do not apply to business-purpose credit. While federal law generally does not mandate cost disclosures for business credit, a few states such as California and New York now require certain commercial financing disclosures; check your own state’s requirements. For background on business financing with nothing being sold, the SBA business guide and the FDIC’s Money Smart for Small Business are neutral sources.
Common questions
Why is there no calculator on this page?
Because the answer depends on an assumption about your own usage that no page can make for you, and a calculator that hides that assumption produces a confident wrong number.
What do I divide the total cost by?
The average balance across the whole year, not the limit and not the balance while drawn. Anything else flatters or punishes the facility unfairly.
How do I compare it against a term loan?
Put both on cost per dollar borrowed per year. The facility's figure moves with your assumed usage, so quote it as a range across a light and a heavy pattern.
What if my usage turns out different from my assumption?
Then your cost is different, which is the point. Revisit the sheet with real numbers after a full cycle and see which way the assumption was wrong.
