What Is a Commercial Loan?

Commercial loans have one purpose—to help you operate and grow a business. There are several types of commercial loans, and one of them might be right for you. Other options might make more sense for smaller companies and lower loan amounts.

Technically, a commercial loan isn’t made to an individual. It’s made to a business, and the business is responsible for repayment. Most lenders use the term “commercial loan” to refer to larger loans made to medium-sized or large companies (generally, businesses with annual revenue of $10 million to $1 billion). 

How Do Commercial Loans Work?

Businesses in need of money apply for a commercial loan from a bank, credit union, or another lender. They'll need to fill out paperwork and provide details on their business finances. This helps the lender decide whether it wants to work with the business and what the interest rate should be. The better credit a business has, the lower its interest rate will be.

Business owners can generally choose between a term loan and a line of credit. A term loan gives you a fixed amount of cash that you pay back in monthly installments over a certain number of years. This works well if you need a large sum of cash upfront and anticipate a one-time need to borrow.

A line of credit works like a credit card. You're given a limit that you're allowed to borrow up to, and you pay interest on your outstanding balance. Paying back what you owe during the loan term will enable you to borrow more again in the future, if needed. 

Regardless of the type of commercial loan you choose, you'll likely need to put up collateral. This is something you give the lender permission to seize and sell if you can't make your payments as scheduled. Commercial loan collateral is often real estate or equipment you use in your business.

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What's the Difference Between a Commercial Loan and a Business Loan?

Some lenders use the terms "commercial loan" and "business loan" interchangeably, while others make a distinction based on business size. In this case, "business loan" typically refers to loans for smaller businesses while "commercial loans" are for larger businesses. 

One study from the National Bureau of Economic Research found that small businesses seeking loans often had shorter loan terms and were required to post more collateral than larger businesses. This could be because larger, most established businesses present less of a default risk than newer, smaller businesses.

But every lender is different in terms of what it offers and its qualification requirements. If you're looking to borrow money, you can explore both commercial and business loan options to see which makes the most sense for you.

Types of Commercial Loans

Lenders distinguish commercial loan types by their collateral, how they’re repaid, and what you use them to finance. Here are the most common options.

Term loans

These are straightforward loans that usually come with fixed interest rates and monthly payments. Borrowers choose a loan amount and a repayment term (which can last up to 20 years). You make regularly scheduled payments determined by the loan term and amount, payment frequency, and interest rate. 

Short-term loans

Short-term business loans are smaller than other commercial loans, and are normally paid back in no more than 18 months. The approval process is more streamlined than that of a term loan, which means you could get your money more quickly. Short-term loans are helpful for covering operating costs, such as purchasing inventory, meeting payroll, or funding an unexpected repair. 

Equipment loans

You usually use an equipment loan to purchase big-ticket assets for a business, such as machinery. The item you're taking out the loan to buy often serves as collateral for the loan. Loan terms may last up to 10 years.

Commercial real estate loans

These loans enable you to buy real estate, like a factory, warehouse, or office. As with equipment loans, the property being financed serves as collateral for the loan. Commercial real estate loans have the longest terms, and usually the largest loan amounts. You may need to make a down payment of up to 30% of the purchase price when taking out a commercial real estate loan.

Line of credit

Lines of credit function like giant credit cards for a business. Businesses can use their lines of credit as needed, up to their limits. Business lines of credit can be secured or unsecured. This means they may have collateral or they may not.

Debt consolidation loans

Businesses that are struggling financially could take out a debt consolidation loan to help them pay off their debts more quickly. A debt consolidation loan gives you just one payment to worry about rather than juggling multiple payments. This is just one of several debt relief options for business owners who want to streamline or optimize their debt.

SBA commercial loans

Even though SBA stands for Small Business Administration, SBA commercial loans can provide as much as $5 million in funding, and can be used by medium-sized businesses. The SBA offers commercial term loans, real estate loans, and lines of credit. 

The SBA doesn’t lend money itself. It partially guarantees repayment of a business loan, which you’d get from a bank or other commercial lender. To cover the cost of this guarantee, companies pay fees to the government. SBA guarantees help fund businesses that might be rejected for a regular commercial loan.

How to Qualify for a Commercial Loan

Businesses looking for commercial loans can get them from traditional lenders like banks and credit unions, online lenders specializing in commercial loans, or the SBA program. Commercial loan providers consider most of the same factors that personal and residential lenders do:

• Credit score: Either your personal credit or that of your business

• Income: Your business revenue over the past several years

• Security: The collateral you’ll forfeit if you don’t repay the loan

• Loan use: Your business plan and how your company will use the loan proceeds

• Business health: Financial statements showing what your business owns (assets), its debts (liabilities), its profits, and its losses

Documentation requirements depend on the lender and the type of loan. SBA loans and traditional lenders require financial statements, tax returns, and full business plans. Online lenders may allow more relaxed documentation if you meet their revenue requirements. 

It's common for lenders to require potential borrowers to provide balance sheets, which give a list of the assets (things you own) and your liabilities (things you owe), and your cash flow statements. This gives lenders an idea of how much money your business is making and spending. These forms give lenders some insight into whether you'll have a steady cash flow to pay your bills back and whether taking on a new loan will strain your budget too much.

Lenders also look at your business's debt-to-income (DTI) ratio. This is all your monthly debt payments divided by your gross monthly income—your monthly income before taxes. For example, if your monthly debt payments were $10,000 and your monthly income was $50,000, your DTI ratio would be 20%. 

Typically, you want to keep your DTI ratio under 50% when you're hoping to apply for a commercial loan. Under 30% is even better. This tells lenders that you're operating comfortably within your means.

A lender might also ask to see your business plan. This is a report explaining how your company operates and what you hope to use the loan money for. You'll need to explain your business and your product or service, including why there's a market for it and why your company has a unique edge over its competitors. 

You'll also want to describe how the company is organized and how you plan to market your product or service to customers. If you can show that you have a business with strong leadership and a clear marketing strategy, you’ll give lenders more confidence that your business will be able to succeed and you’ll pay back your obligations.

Finally, you'll need to explain what you plan to use the money for. You'll want to be specific and explain how your intended use for the money will further your business's growth and increase profits.

Expect to go through a credit check as part of the application process too. This gives lenders insight into how you've managed borrowed money in the past. Generally, a FICO Score of at least 680 is required for loans from commercial banks and other traditional sources—and higher is always better. 

Those who have fair or poor credit may have difficulty getting approved for a commercial loan right away. If large amounts of debt are dragging down your finances, you may need to explore debt relief and focus on rebuilding your credit before you try to get additional funding for your business.

If you have any questions about what documentation you need to apply for a business loan, you can always reach out to the lender to ask. You might be able to save yourself some time by putting together commonly requested documents, like your balance sheet or cash flow statement, before you begin to fill out your loan application.

Factors That Could Affect Commercial Loan Terms

Every commercial loan is unique in terms of how much you're borrowing, how long the loan term lasts, and what your interest rate is. These factors all play a critical role in how much the loan costs you over time. 

A larger loan amount typically takes longer to pay back. Longer loan terms mean more months of payments, which can lead to you paying more in interest overall. 

Interest rates vary depending on several factors, including:

• Credit score: The higher your credit score is, the lower the interest rate lenders are usually willing to offer you.

• Collateral: Loans with collateral are less risky to the lender because there's something they can seize and sell to recoup their money if you don't make payments. As a result, most lenders offer lower interest rates on loans backed by collateral.

• Business financials: Businesses with a strong financial outlook are perceived as less risky than new businesses or businesses experiencing financial difficulties.

• Economic conditions: Interest rates tend to rise and fall over time. They're often tied to the prime rate—a benchmark rate that banks use when setting their interest rates. When this goes up, interest rates across the board tend to rise.

Lenders also use their own discretion in deciding what types of interest rates to offer their customers. This is why it's important to get offers from several commercial lenders so you can see which one offers you the most favorable terms. Aim to compare at least three lenders if you can before deciding which you want to work with.

Commercial Loan Pros and Cons

Commercial loans are geared to the specific needs of medium-sized companies. This makes them great for the right uses, and not great for the wrong ones.

Pros of commercial loans

Here's a closer look at the advantages of commercial loans:

• Money when you need it: Business loans could give you the cash you need to run or grow your business when your revenue alone isn't enough.

• Fixed payments: Commercial loans generally have regular monthly payments that don't change over the life of the loan, so they're easier to budget for.

• Match repayment schedule to your revenue: Some creditors may let you adjust your payments based on your revenue, which can be a big help for seasonal businesses.

• Potentially tax-deductible interest: You may be able to deduct the interest you pay on your commercial loan as a business expense on your taxes.

• Retain control of your business: Commercial loans could help you get the money you need without selling shares in your company and diluting your ownership.

Cons of commercial loans

Commercial loans have their drawbacks, including:

• Applications take work: It can take time to gather all the necessary information for your commercial loan application, and then you have to wait for the lender to review it all and approve you.

• May have to put up collateral: Loans backed by collateral typically have lower interest rates, but you're also pledging to give the collateral to the lender if you can't keep up with your payments.

• Fees associated with borrowing: You pay closing costs with a commercial loan, just as you would with a mortgage or personal loan.

Best Commercial Loan Uses

Commercial loans are designed to help businesses grow. You’d use them for costs like:

• New equipment purchases: Using the new equipment to secure the loan frees up assets for other projects.

• Facilities renovation: This can help you upgrade the size, efficiency, or safety of your workspace.

• Working capital when your cash flow is interrupted: This can help you make payroll, restock inventory, or handle bills when your business is temporarily short on funds.

• Business real estate purchases: This can be critical when starting a business or expanding to a new location.

• Targeted improvements: Commercial loans can help you improve your marketing, hire new staff in key areas, or target new sectors.

The right commercial loan use should increase business revenue and more than pay for itself, so choose your projects carefully. 

Commercial Loan Alternatives 

Commercial loans aren't your best option in every scenario. Small businesses are often better served by other financing options. Here are a few popular alternate ways to start, expand, or operate a smaller business.

Business grants

Business grants are money that the federal government or a private source gives to you without any expectation of repayment. However, the money typically must be used for a specific purpose, like growing your business. You have to apply for grants and the process can be similar to applying for a business loan. You’ll need to provide the same sorts of information about your business, like your financial statements and business plan. If you're approved, though, this could be much better for your business finances over the long term.

Invoice factoring

Invoice factoring is where a business sells their unpaid invoices to a factoring company at a discount. This can be a win-win situation if you need cash in a hurry. The factoring company pays you quick cash and it stands to make a profit when the customer finally pays the invoice.

Crowdfunding

Online crowdfunding platforms like Kickstarter and GoFundMe let you solicit small contributions from individuals. These could be donations or there could be a trade involved where they get some sort of product or service later in exchange for making a contribution. 

Home equity loans

Home equity loans are secured by real estate, which makes them safer for lenders and less expensive for business owners. They are installment loans similar to term loans with (usually) fixed interest rates and fixed monthly payments. However, when your home secures a business loan, you risk losing the home if your enterprise fails.

HELOC

A home equity line of credit, or HELOC, is similar to a home equity loan, but it gives you access to a line of credit (like a credit card), instead of a fixed dollar amount. HELOCs are also secured by your home, and usually come with a relatively low fixed or variable interest rate.

Personal loan

Personal loans are loans you can take out for any purpose, including debt consolidation. They don't require collateral, so they could be a good fit if you're not comfortable putting assets like your business equipment or your home on the line. However, since they lack collateral, personal loans usually come with higher interest rates.

Settling your debt

Settling your existing debt may free up some room in your monthly budget that you can put toward growing your business expenses. This is where you offer to pay the creditor less than the full balance and request that they treat it as full payment. It may be possible to settle certain business debts, like credit cards. But generally, if you put up collateral for a loan, settling that debt isn't an option.

If you need debt relief in Colorado Springs, CO (or anywhere else in the country), explore your options. The first step is the most important one—find out more today.

If you own a small business or a sole proprietorship, you may be able to settle your personal debts to create some wiggle room in your monthly budget. Unsecured debts, like credit cards and personal loans, are great candidates for debt settlement. You can do this on your own or with the help of a company like Freedom Debt Relief. Here’s how our program works.