What is a Commercial Loan?

A commercial loan is a type of debt financing where a business borrows money from a bank, credit union, or other financial institution.

A person writing at the table

Commercial loans serve many purposes. Companies can use a commercial loan to achieve various goals, such as expanding their operations, entering new markets, acquiring real estate or equipment, or reducing debt burdens. Before taking out a commercial business loan, it’s best to look into the different types of loans available and how to get one.

Key Takeaways

  • Businesses typically use commercial loans to fund various expenses, such as inventory, real estate, or operating costs.
  • Many lenders require collateral and detailed financial statements before approving a business loan.

What is a Commercial Loan?

A commercial loan is a type of debt-based financing businesses use to fund different expenses. With a commercial loan, you borrow money from a financial institution, such as a bank or credit union, and repay the funds over time.

Commercial loans typically have lower interest rates, fixed repayment periods, and a quick turnaround time for approval. They can be secured or unsecured. A secured loan is backed by a business’s collateral, such as property or inventory. If the business defaults on the loan, the bank can take control of its assets to pay the debt. For example, if your company uses its building as collateral, the lender has the right to repossess the building if you default on payments.

On the other hand, unsecured commercial loans do not require collateral. They are more common, and the terms are usually determined by a business’s creditworthiness and financials.

Commercial Loans vs. Business Loans

In general, commercial loans and business loans are used interchangeably. They are both money a company borrows from a lender to cover their expenses. However, sometimes commercial loans may refer to financial offerings for larger companies, while business loans are meant for smaller companies. Commercial loans may also have more complex application processes and stricter qualification requirements because they are usually available in greater amounts.

How Commercial Loans Work

Businesses typically take out commercial loans for short-term funding purposes. For example, they may use a commercial loan to help them meet basic operational needs, such as covering payroll or purchasing equipment. Depending on the type of loan, the lender may ask for collateral in the form of a business’s assets or cash flows generated from future accounts receivables.

With a commercial loan, the lender will provide your company with a lump sum you’ll need to repay over a set period with interest. Sometimes, these loans may get structured as a line of credit. Similar to a credit card, you would have access to funds up to your credit limit. You’ll only pay interest on the funds used, and the credit line resets when you repay the balance.

Lenders will evaluate your business’s creditworthiness, time in business, and revenues. Most lenders will require your business to provide financial documentation, such as balance sheets, to prove that your company has consistent cash flow. This reassures the lender that your business can repay the debt.

Additionally, if you are a startup, you may have a harder time getting a loan than an established business. Lenders may also require a certain amount of annual or monthly revenue before extending the loan, typically confirmed by bank statements.

Other qualifications may include a business plan or financial statements explaining how you will use the funds and how the business will grow over time. Your business may also need to operate as a business entity, such as being structured as an LLC or corporation.

Types of Commercial Loans

There are 2 main categories of commercial loans: short-term (less than 12 months) and long-term commercial loans (more than 12 months). Commercial loans can also be used for specific purposes, including:

Working Capital Loans

Working capital loans are usually unsecured and meant to finance a company’s short-term capital needs. They can be used for everyday expenses such as buying inventory and equipment, hiring additional staff, or other operational costs. These loans are typically meant to be repaid in less than a year and should be used only for working capital purposes. Banks and other financial institutions may offer these to small and medium-sized businesses. At the end of the loan term, a company will likely repay the loan by converting inventory or accounts receivable to cash.

Equipment Financing

If you need to purchase heavy-duty machinery or general-purpose equipment for your business, yon can take out an equipment loan with a specialized equipment finance company like Crest Capital Equipment Financing, OnDeck, or National Business Capital. Alternatively, you can apply for a loan from banks, online, and SBA lenders, You can use an equipment loan for office furniture, medical equipment, farm machinery, etc. These loans are usually secured by the equipment. If you don’t repay your debt on time, the lender could seize your equipment.

Real Estate Loans

Similar to taking out a mortgage, businesses can use a commercial real estate loan to buy or renovate properties. For instance, they can use the loan to purchase residential properties or cooperatives, land, forests, or for construction projects. Some states consider oil and mineral rights real property, allowing businesses to buy them with a real estate loan.

Down payments on commercial real estate loans can range anywhere from 15 to 35%, slightly higher than residential properties. Repayment terms are also shorter, typically ranging between 5 and 20 years. The loans can be either mortgage or non-mortgage loans. Mortgage loans are secured by the property itself while non-mortgage loans are unsecured.

yellow and black heavy equipment on brown field during daytime

Auto Loans

You can use commercial auto loans to buy vans, trucks, or other vehicles for your company. They can also be used to modify existing vehicles with special business equipment or to add accessibility features such as mobility lifts and right-hand drive capability. These loans typically use the vehicles you are financing as collateral. They may have certain requirements, such as a minimum vehicle value, maximum vehicle age, and maximum mileage.

Construction Loans

A commercial construction loan can be used to cover the costs of building or renovating office space, multi-family real estate investments, or other projects. You can use the loans to buy land and materials and pay workers. During the construction period, lenders typically accept interest-only payments. Once construction is completed, they will start charging higher payments. Usually, lenders will only finance 70 to 90% of the costs, and the property may serve as collateral for the loan.

Where to Get a Commercial Loan

Banks and Credit Unions

If your business has been around for 2 years and has good credit, you have a high chance of qualifying for a commercial loan from a bank or credit union. Note that they may check your personal credit and your business’s credit score. Depending on the lender, you may need to meet other requirements, such as securing your loan with collateral and having a minimum annual revenue. While the process may be lengthier than with lenders, banks and credit unions usually offer lower interest rates.

Small Business Administration (SBA)

The Small Business Administration (SBA) is a federal government agency dedicated to helping small businesses and entrepreneurs. SBA loans typically offer better terms than other commercial loans and are partially guaranteed by the federal government. Because of the guarantee, lenders have more protections and feel comfortable offering additional incentives, such as lower interest rates and longer repayment terms. Loans may range from $500 to $5.5 million, but businesses must meet more stringent standards to qualify.

SBA 504 Loans

The SBA 504 loan is designed for businesses to acquire commercial equipment or real estate. With the 504 loan, you can get up to $5 million in funding, longer repayment terms, and lower interest rates with minimal collateral. You will also have access to local Certified Development Companies (CDC), nonprofit partners that support developing surrounding communities.

SBA 7(a) Loans

The 7(a) loan is one of the most common types of loans the SBA offers. SBA 7(a) loans offer favorable terms for small businesses and can be used for various purposes, including working capital, business expansion, and buying equipment or machinery. They are designed for companies with under $35 million in revenue and come with stringent criteria.

SBA Microloans

SBA microloans are an affordable option for startups and early-stage businesses, offering up to $50,000 for purchasing equipment, inventory, fixtures, etc. These loans are available for small-business owners with no credit history or lower incomes.

Online Lenders

Compared to banks and credit unions, online lenders tend to have faster application processes and funding times, sometimes within a day. They may also have more flexible borrowing requirements, which is helpful if you are a startup or early-stage company. While the interest rates may be higher, you’ll also have higher loan approval odds. But, before applying with an online lender, ensure the lender is registered with an appropriate agency and is a reputable business.

Nonprofit Lenders

Nonprofits typically focus on lending to local businesses, especially those who don’t qualify for traditional financing options, such as women and minority-owned businesses. These lenders offer a range of products and often provide business training and coaching. For example, Main Street Launch is a Bay Area-based nonprofit that lends to entrepreneurs in low-to-moderate-income communities. Some nonprofit lenders also offer SBA microloans.

How to Get a Commercial Loan

1. Decide What Type of Financing You Need

Before applying for a loan, consider how much you need to borrow, how fast you need the funds, and what you need to finance. For example, if you want to purchase a property, you’ll probably want a commercial real estate loan. Be prepared to discuss your business plan with the lender as they may ask you more details about your business and why you need financing.

2. Figure Out How Much You Can Afford to Borrow

Look at your finances and determine how much your business can realistically borrow to achieve your business goals while maintaining an affordable monthly payment. If you borrow more than your business can afford to repay, that can put you in a tough situation when you don’t have the funds to make your payments.

3. Evaluate Your Creditworthiness

Generally, to qualify for a business loan from a traditional lender like a bank or credit union, your business needs to have been operating for at least 2 years and have good credit and strong annual revenue. Lenders will typically also look at your personal credit score to gauge your ability to repay your debt.

4. Shop Around For Lenders

Take time to shop around and compare lenders to find the right fit for you. Consider factors such as how much you can borrow, interest rates, fees, application process, and lender reputation. If your business is new, you may need to guarantee the loan with your personal assets. If the business defaults on the loan, the commercial lender can recover the funds from you.

5. Apply For a Loan

Once you’ve found the right lender, you need to submit an application. Most lenders will ask for business documents, such as tax returns, financial statements, accounts payable, collateral, and a business plan. After you receive an offer, review the terms carefully before accepting.

6. Start Repayment

After receiving the loan, you will likely need to start making fixed monthly payments to the lender over a set period. Consider setting up automatic payments so you never miss a payment. Paying on time can help your business build credit while avoiding delinquency or default.

The Bottom Line

There are many types of commercial loans and they can be used for various business expenses. Before taking out a commercial loan, consider your business goals, loan terms, cash flow, etc. These factors will help you decide which loan is right for your business.

We are not financial advisors. The content on this website and our YouTube videos are for educational purposes only and merely cite our own personal opinions. In order to make the best financial decision that suits your own needs, you must conduct your own research and seek the advice of a licensed financial advisor if necessary. Know that all investments involve some form of risk and there is no guarantee that you will be successful in making, saving, or investing money; nor is there any guarantee that you won't experience any loss when investing. Always remember to make smart decisions and do your own research!

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