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 companies (generally, businesses with annual revenue of $10 million to $1 billion). 

Types of Commercial Loans

Lenders distinguish commercial loan types by their collateral (something you pledge to give the lender if you can't keep up with your payments), 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 go up to $5 million, 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.

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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. 

What credit score do you need for a commercial loan? Generally, at least a FICO score of 680 for loans from commercial banks and other traditional sources—and higher is always better. 

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.

• 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 things 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.

Home equity loans

Home equity loans are secured by real estate, which makes them safe 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 it if your enterprise fails.

HELOC

The 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. The HELOC is also secured by your home, and usually comes with a relatively low fixed or variable interest rate.

Personal loan

Personal loans are loans you can take out for any purpose. 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 charge higher interest rates.