Commercial Loan: Definition, How It Works, Types

What Is a Commercial Loan?

A commercial loan is a money-lending relationship between a business and a financial institution. Businesses typically take out loans because they are growing at a rate where they require expansion of some type, which may include more equipment, office space, and even more robust operations. While businesses can also use their own profits, attract investors, or seek alternative financing options, a loan is a good way for a business to obtain the capital it needs to be able to hit their goals or benchmarks for growth. However, with the loan, business owners are better able to grow the business and generate the revenue they need to not only pay back the loan but to increase their capital, too.

How Commercial Loans Work

Most business owners apply for a commercial loan so they can get to the next stage in their business. This short-term funding helps with the operations of the company on either a large or small scale. Loans can be used for nearly anything from the purchase of a commercial building to funds needed to pay a surge of contract employees.

Once a business owner has identified that their company is in need of a loan to continue operations, they usually have to approach the financial institution with collateral. This collateral will end up becoming the bank's property if the business defaults on its loan or goes bankrupt. A business can also seek an unsecured loan without having to put up collateral, but this is less common.

When making a lending decision and signing a loan rate with terms, the financial institution may look at a number of factors, including:

• Your company's finances: Similar to consumer loans, an institution issuing the loan will want to take a look at your company's finances, debt service coverage ratio (similar to the debt-to-income ratio for consumer loans), and credit profile to determine your company's creditworthiness and ability to repay the debt. The financial institution wants to see the company's balance sheets to showcase cash flow and any liabilities it currently has.
• Your personal information: It's common for an individual to have a better credit history and credit score than their business, especially if the business is new. In this case, the bank may request information to assess your personal creditworthiness too.
• The property you need a loan for, if applicable: If you're applying for a real estate or construction loan for your business, the financial institution may also want information about the property to determine things like appraised value.

Types of Commercial Loans

Here are a few of the many types of business loans:

• Business line of credit: A business line of credit is similar to a credit card in that it's revolving, although a line of credit is typically used for larger amounts and has different repayment terms compared to a credit card. It's useful if you need a lump-sum of cash, want to choose when and how you use it, and want to avoid paying interest on any amount you don't end up using.
• Business credit cards: This is a common loan that small businesses take on so they can track expenses, manage spending, and purchase items they may not be able to afford with cash. Just like consumer credit cards, interest rates vary depending on creditworthiness. Because of this, look for credit card offers that suit you well, like a 0% introductory APR or a card that gives rewards based on how much you use it.
• Construction loans: Construction loans are specifically to build new property, renovate existing property, or make repairs. You can use the loan funds to pay a company to perform the work and to pay for the cost of materials.
• Hard money loan: These loans usually have short loan terms of mere months up to two years. They are mostly issued by private investors or specialized financial institutions who charge a higher interest rate, but they can be useful for business owners who need money quickly and expect to pay off the loan quickly, too.
• Blanket loan: If you have multiple properties, then a blanket loan may be a good option as long as you understand the downsides. While a blanket loan may be very convenient for you to manage funds, they usually involve hefty payments and strong penalties if you default on the loan.
• Real estate loan: Real estate loans are for purchasing new business property. Loan terms typically range from five to 20 years, and it's not uncommon to have a balloon payment after a specific number of years of the term. You may also expect to pay higher interest rates and fees for items like an appraisal, survey, and loan origination documents. Many business owners who don't want to purchase property rent it instead. If you want to go this route, there are different types of commercial real estate leases to be aware of.
• SBA loans: These loans are given by lenders and are guaranteed in part by the Small Business Administration. There are many small business loans available, but in general, the SBA requirements are that your business is a small for-profit entity that operates in the United States. These loans give your business a surge of capital to use on what you need.

Where to Get a Commercial Loan

While you may immediately think of a bank for where you should go to get a commercial loan for your business, there are other options. Here are some details about banks and other options for lenders:

• Banks: Banks typically provide good rates and long-term options to keep payments reasonable for the business. However, they tend to be more selective and the process for acquiring a loan is longer.
• Commercial lender: In addition to banks, there are also other commercial lenders that are able to issue loans. You can expect lower costs and faster approval compared to banks, but the interest rates are usually higher and the loans are short-term.
• Hard-money lenders: Private companies usually dole out hard-money loans, which are short-term and require little time or documentation for approval. However, these lenders typically charge higher interest rates.
• Crowdlending: Crowdlending happens on marketplaces where borrowers and lenders are matched according to need. There is less regulation on these platforms than there is in traditional lending methods, so engage at your own risk.

Advantages of a Commercial Loan

It's helpful to know the advantages of a commercial loan so you can make the right decision for your business. Advantages include:

• Money right away: Even if the loan approval process is lengthy, you'll end up with funds more quickly than saving your revenue and waiting for your available funds to be what you need them to be.
• Manageable payments: Even if you take out a large loan, you should have a manageable repayment amount every month.
• Tax-deductible interest: Although you will be paying interest on your commercial loan, the interest you pay is tax-deductible, which can help you at the end of the year.
• No need to bring on investors: You either started your business on your own or with a core group of people. You could bring on an investor who will supply the business with needed funds, but then you are probably also giving up a part of your ownership in the business in exchange. A commercial loan can give you the capital you need without compromising your percent of ownership in the company.

Commercial loans are a great way to get the cash you need to continue growing your business, which is a business owner's dream. Commercial loans are not something to shy away from; rather, they can provide the means to get the equipment, property, and people you require to make your business an even bigger success.