What Is a Commercial Loan and How to Apply for It?

March 28, 2023

What Is a Commercial Loan? As a business owner, you may require financing to help grow or sustain your operations. One option for funding is through a commercial loan.

A commercial loan is a type of financing provided by a financial institution, such as a bank, credit union, or alternative lender, to businesses seeking capital. In this article, we’ll provide an overview of commercial loans, how they work, and the pros and cons of this financing option.

What Is a Commercial Loan?

A commercial loan is a loan provided to businesses for various purposes such as expansion, acquisition, working capital, and refinancing. Unlike personal loans, commercial loans are meant to be used for business-related expenses only and are typically offered to companies rather than individuals.

Commercial loans differ from other types of loans such as personal loans or consumer loans in that they are generally larger in amount, longer in the term, and may have more complex structures. The loan amount can range from a few thousand dollars to millions of dollars depending on the size of the business and the intended use of funds.

Commercial loans are secured or unsecured. A secured loan is backed by collateral, such as business assets, while an unsecured loan is not. Secured loans typically have lower interest rates than unsecured loans because they are less risky for the lender.

Types of Commercial Loans

There are several types of commercial loans available, including term loans, lines of credit, SBA loans, and commercial real estate loans.

Term loans are the most common type of commercial loan. They are a lump sum of money borrowed by a business and repaid with interest over a fixed period, typically between one to ten years. Term loans are used for a variety of purposes, such as financing equipment purchases, working capital, or expansion.

Lines of credit are a flexible form of financing that allows businesses to borrow money as needed up to a certain credit limit. Similar to a credit card, interest is only charged on the number of funds used, and repayment terms vary depending on the lender.

SBA loans are loans backed by the Small Business Administration (SBA), a government agency that provides support to small businesses. These loans are designed to help small businesses access financing that may not be available through traditional lenders. The SBA offers several loan programs, including the 7(a) loan program, which provides funding for a variety of business purposes, and the 504 loan program, which provides funding for real estate and equipment purchases.

Commercial real estate loans are loans used to purchase or refinance commercial real estates properties such as office buildings, warehouses, or retail spaces. These loans are typically larger than other types of commercial loans and may have longer repayment terms.

How Does a Commercial Loan Work?

The process of obtaining a commercial loan varies depending on the lender, but generally follows these steps:

Application: Businesses must complete a loan application and provide financial information to the lender, such as financial statements, tax returns, and cash flow projections.
Underwriting: The lender reviews the application and financial information to determine the borrower’s creditworthiness, including their ability to repay the loan.
Approval: If the loan is approved, the lender will provide a loan offer detailing the loan amount, interest rate, and repayment terms.
Funding: Once the borrower accepts the loan offer, the funds are disbursed to the borrower’s account, usually via wire transfer or check.

Interest rates for commercial loans can vary depending on several factors, including the borrower’s creditworthiness, the loan amount, the loan term, and the lender’s policies. Commercial loans may also have additional fees such as application fees, origination fees, and prepayment penalties.

Pros and Cons of Commercial Loans

Before considering a commercial loan, it’s essential to understand both the advantages and disadvantages of this financing option.

Pros

Access to Capital: Commercial loans provide businesses with access to larger amounts of capital than other financing options, such as personal loans or credit cards. This can be especially beneficial for businesses looking to finance significant investments or expansions.
Flexible Terms: Commercial loans offer more flexibility in terms of repayment than other types of loans. Businesses can typically choose from a variety of repayment terms and structures to meet their specific needs.
Potential Tax Benefits: Interest paid on commercial loans may be tax-deductible, which can reduce the overall cost of borrowing.

Cons

Higher Interest Rates: Commercial loans often come with higher interest rates than other types of loans, reflecting the greater risk involved for lenders.
Collateral Requirements: Secured commercial loans require collateral, which means that if the borrower defaults on the loan, the lender can seize the collateral to recover their losses.
Strict Requirements: Commercial loans typically have stricter requirements than other types of loans, such as higher credit score requirements and more extensive documentation.

How to Apply for a Commercial Loan

Applying for a commercial loan can be a time-consuming process, and businesses should be prepared to provide a significant amount of financial documentation. Here are the steps to follow when applying for a commercial loan:

Determine the type of loan needed: Before applying for a commercial loan, businesses should determine the type of loan they need. There are various types of commercial loans available, including term loans, lines of credit, and commercial mortgages. Each type of loan has its own requirements and terms.
Identify potential lenders: Once businesses have determined the type of loan they need, they should research potential lenders that offer that type of loan. Local banks and credit unions are good places to start, but there are also online lenders that specialize in commercial loans.
Gather financial documentation: Lenders will require a significant amount of financial documentation to evaluate a loan application. This may include financial statements, tax returns, cash flow projections, and business plans. Businesses should be prepared to provide all the necessary documentation.
Complete the loan application: Once all the necessary documentation has been gathered, businesses can complete the loan application. This may be done online or in person, depending on the lender.
Wait for a decision: After submitting the loan application, businesses will need to wait for the lender to evaluate their application and make a decision. This can take anywhere from a few days to several weeks.
Review the loan terms: If the loan application is approved, the lender will provide the business with a loan offer that outlines the loan terms, including the interest rate, repayment terms, and any fees. It’s important to carefully review the loan offer and make sure the terms are acceptable before accepting the loan.
Repay the loan: Once the loan has been accepted, businesses must make regular payments according to the loan terms to avoid defaulting on the loan.

In conclusion, commercial loans can provide businesses with access to larger amounts of capital and flexible repayment terms. However, applying for a commercial loan requires significant preparation and documentation, and businesses should carefully consider the loan terms before accepting a loan offer. With proper planning and preparation, a commercial loan can be a valuable financing option for businesses.

What Is a Commercial Loan and How to Apply for It?