Commercial Loans: What It Is & How It Works

august 21 2023 blogA commercial loan can provide businesses with the funding they need to purchase real estate for setting up their operations, expanding facilities, purchasing equipment, funding working capital, paying down debt, and other business-related expenses.

There are many different commercial loan products available across a range of lenders, and it is important to apply for the right type of loan to meet your business’s objectives. Here is a closer look at how these loans work.

The Basic Premise of a Commercial Loan

A commercial loan may be extended to a business to help with their short-term funding needs. These loans typically require the business to post collateral, which may be in the form of property, equipment, or inventory that the bank can seize from them should they default on the loan or go into bankruptcy. In some cases, the cash flow from future accounts receivable may also be used as collateral on a commercial loan.

If the company does not have a credit rating or lacks an established track record, that does not necessarily mean they will not be able to obtain a commercial mortgage or other type of loan. However, in these cases, the owners are often required to guarantee the loan using personal assets.

Commercial Lending Rates

The interest rate a business will be offered on a commercial loan depends on several factors, including the nature of the business, the business’s credit history, the features of the loan, and the amount of collateral they can offer. For commercial mortgage loans, companies can expect to pay anywhere from 1 to 2.5% more in interest than they would on a residential mortgage.

Supplying Documentation

To obtain a commercial loan, businesses must fill out an application, provide thorough supporting documentation, and ensure everything is accurate. Proof of the organization’s ability to repay the loan is essential. This might include tax returns, bank statements, revenue projections, and cash flow. Banks will also request a detailed business plan.

Types of Commercial Loans

Here is a closer look at some of the most common types of commercial loans.

Commercial Mortgage Loan

A commercial real estate loan functions in a similar manner to a home mortgage, but real estate loans for businesses typically have a repayment schedule in the 5 to 10-year range rather than the longer terms offered by home mortgages. They also require a business to occupy at least 51 percent of the commercial property the loan will be financing. Other qualifications include being in business for at least a year and a personal FICO credit score of at least 700.

These loans are available with variable or fixed rates. A variable rate means the interest rate may rise or fall depending on current market trends, which can affect the monthly payment. A fixed-rate mortgage, meanwhile, has a steady rate, allowing for a predictable interest and payments.

Business Line of Credit

With a business line of credit, companies can borrow up to a certain amount of money but are only required to pay interest on the amount they are actually using. For example, if a business extends a line of credit of $100,000 but they are just using $20,000 of it, they will only have to pay interest on $20,000. This is one of the most flexible types of business loans and is often the preferred choice for general working capital needs. These almost always have a variable rate of interest.

Small Business Administration Loans

A Small Business Administration (SBA) loan tends to offer better terms than other types of commercial loans and is partially guaranteed by the federal government. Although it is not made directly by the SBA, it must be obtained from a SBA-guaranteed lender. This provides the lender with greater protection and allows them to offer longer terms and lower interest rates. However, the process of applying and being approved for this type of loan tends to be complicated.

Commercial Bridge Loans

A bridge loan can provide a business with fast financing that can close the gap until they are able to secure longer-term financing for a commercial property. This may prove useful in cases where a business owner needs to compete against all cash bidders on a property; they can later refinance to a long-term loan once they have obtained the property.

Bridge loans tend to come with very short terms – often somewhere between six months and three years – and must be fully paid off after they mature. They tend to have higher interest rates than the going market rate in exchange for this convenience.

It can also be more challenging to qualify for this type of loan, with business owners generally required to have a low debt-to-income ratio and very strong credit to gain approval. Companies can expect to make a down payment of between 10 and 20% on this type of loan.

Reach Out to the Community Commercial Bankers at Woodsboro Bank

At Woodsboro Bank, we understand the needs of our community’s businesses and the important role they play in supporting our local economy. We offer customized financing options that can help your company grow and thrive. Contact us today to learn more about our services and schedule an appointment with our business banking team.

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