Commercial Loan Types and How They Work
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A commercial loan generally encompasses all business financing and can be used to fund small and large business purchases — from buying inventory to constructing a new building. Commercial lending comes in various forms, and its terms and rates will vary by the lender and loan type. Securing a commercial loan can be essential to starting or growing your business, and can offer financial support when your business is struggling.
What is a commercial loan?
A commercial loan is funding that financial institutions like traditional banks or online lenders issue to a business. Commercial loans can fund major purchases and cover daily operational costs. There are multiple types of small business loans, from term loans to lines of credit.
Types of commercial loans
General-purpose loans can be used for a wide range of business expenses, while commercial real estate loans typically finance property- and construction-related costs.
General-purpose commercial loans
A commercial term loan looks like a traditional loan — the borrower receives a lump sum of funding and must repay it over time. Online lenders typically offer loans of $5,000 to $500,000 or more, with repayment terms of three to 18 months for short-term loans and 25 years for long-term loans.
Long-term loans are ideal for significant purchases, such as buying manufacturing equipment or remodeling facilities. Short-term loans are suitable for immediate demands, like funding payroll during a slow season.
Interest rates can range from 2.5% to 99%, depending on the lender and loan type. Applicants should have at least one year in business, a 580 to 600 minimum credit score and at least $75,000 to $100,000 in annual revenue.
SBA 7(a) loans
The 7(a) loan program is the SBA’s flagship product for general business financing, up to $5 million. Eligible expenses include purchasing land, securing equipment and refinancing outstanding debt.
Interest rates are based on the federal prime rate and can be fixed (8.25% to 11.25%) or variable (5.5% to 8%), as of Feb. 14, 2021. Repayment terms can extend up to 25 years.
To qualify for an SBA loan, applicants must operate a U.S.-based, for-profit business and meet SBA size standards.
Equipment loans are useful for financing equipment, like commercial ovens and office furniture. Lenders may finance up to 80% of the equipment’s cost, sometimes up to $1 million. The equipment you finance serves as collateral and the lender could seize it if the loan defaults.
Interest rates range between 3% and 30% or more and must be repaid within one to five years. A 620 credit score, two years in business and $150,000 in annual revenue are the typical minimum requirements.
Business lines of credit
A business line of credit is an open-ended credit source accessible on an as-need basis. Credit limits can range from $1,000 to $250,000 and can fund various business costs, including purchasing inventory, hiring staff and covering gaps in cash flow.
The interest rate is typically 8% to 80% and over and applies only to the amount borrowed. Each withdrawal must be paid within 12 weeks to 24 months.
For secured lines of credit, you’ll need to pledge certain assets as collateral. You should strive for a 650 minimum credit score and one year in business, although some lenders have accepted only two months of time-in-business.
Commercial loans for real estate costs
Commercial real estate loans
A commercial real estate loan is used for obtaining real estate, from securing office space to purchasing residential property for leasing out to tenants. Typically, borrowers can secure a real estate loan up to $5.5 million with interest rates starting at 5%. Repayment terms can extend up to 25 years.
Loan-to-value ratios (65% to 75%) will usually apply, so be prepared to cover the remaining costs out of your own pocket. The business must occupy at least 51% of the property you financed. You should have a 620 minimum credit score, at least two years in business and $150,000 in revenue.
SBA 504 loans
The SBA partners with certified development companies (CDCs) to issue 504 loans up to $5.5 million to finance fixed assets like machinery or buildings. An SBA 504 loan consists of two loans — up to 40% from a bank, credit union or another approved lender and 50% from the CDC (100% SBA-guaranteed). The borrower will provide at least 10% as equity.
Commercial loan rates for 504 loans can range from 2.254% to 2.540%, as of February 2021, while the third-party portion rates will have a maximum rate of 6% above the prime rate. Repayment terms can extend up to 25 years.
Those with a personal FICO Score of 680 or higher and have been in business for two to three years are more likely to qualify for an SBA 504 loan. Business owners must also meet the following requirements:
- Not exceed $15 million in tangible net worth
- Not exceed $5 million in average net income
- Meet job creation and retention requirements
Commercial bridge loans
A commercial bridge loan is a lump sum of cash used to bridge a gap in funding. For instance, a commercial bridge loan can quickly purchase newly available property before another buyer can intervene. The downside to a commercial bridge loan is it usually needs to be repaid quickly.
Commercial bridge loans typically cover 80% of the property’s value, up to $20 million. You will need to cover the remaining amount as your own equity. Interest rates range from 9% to 11% and must be repaid within six to 12 months.
During the application process, lenders may request property details, such as location, condition and outstanding liens. Any major derogatory events in your background, such as bankruptcies or felonies, may affect your chances of getting approved.
A construction loan is a short interim loan used to cover construction costs, up to $1 million. Eligible expenses include paying subcontractors, such as carpenters and electricians, and covering the cost of materials and permits. Interest rates can range between 5.72 to 9.72% and must be repaid within 36 months.
Qualifying for a commercial construction loan typically requires a FICO Score ranging from 620 to 680. Borrowers with a successful history of managing investment properties are more likely to receive the lender’s approval.
How to get a commercial loan in 3 steps
After determining the best loan type for your needs, the next steps are to find a lender, compile your application documents and thoroughly review your loan agreement.
Step 1: Choose a commercial lender.
Commercial loans are available through traditional lending institutions and online lenders. Choosing the right lender depends on the loan type you are seeking, your qualifications and how fast you need funding.
Traditional financial institutions, such as banks and credit unions, often offer more favorable terms but typically carry stricter requirements and a longer application process compared with online commercial lending.
Online lenders are viable options if you don’t think you will qualify for a traditional bank loan. Online business loans typically require less paperwork, have more lenient requirements and are faster to fund. The trade-off is often higher interest rates and smaller funding amounts.
SBA lenders are often traditional banks, though online lenders like SmartBiz offer SBA loans. The SBA’s Lender Match Tool can help you locate a nearby SBA lender.
Step 2: Gather the required documents.
Lenders request documentation to assess a borrower’s riskiness, business experience and ability to repay the loan. Generally, most lenders will require the following documents:
- Business plan
- Business and personal bank account statements
- Business tax returns or personal tax returns for pass-through entities
- Proof of business registration and licenses
- Financial statements, such as cash flow and projections, profits and losses, and balance sheets
- Proof of collateral for secured loans
- Employer identification number
- A listing of business assets and liabilities
Additional documentation may be necessary for certain loans, such as vendor quotes for machinery and equipment on SBA 504 loans.
Step 3: Review your loan agreement before accepting financing.
Understanding your loan agreement before signing on the dotted line can help you avoid undesirable surprises down the road. Be sure to review key details, like the loan amount, repayment terms and what happens if you default on the loan.
If the commercial loan terms look agreeable, you can sign the loan agreement. Depending on the lender and type of loan, it may take one day to multiple months to receive funding after approval.
Commercial loan FAQ
How do commercial business loans work?
A commercial loan is a type of debt financing that business owners can use to fund short- or long-term funding needs. Borrowers will be required to repay the loan over a preset period, plus interest. To qualify for a commercial loan, lenders will review multiple factors, such as time in business, revenue and available collateral.
What are the different types of commercial loans?
General-purpose loans, such as the SBA 7(a) program and lines of credit, can be used for a wide range of business purposes, like working capital, financing equipment, and purchasing real estate. Real estate loans can be used for property- and construction-related expenses, like securing office space or constructing a building.
Where can I find commercial loans?
Borrowers can find commercial loans with favorable terms through traditional financial institutions, like banks and credit unions. Non-bank and online lenders are another option, especially for borrowers who need fast funding or do not fulfill a traditional bank’s requirements, but often have higher interest rates and smaller loan amounts.
How can I qualify for a commercial loan?
To qualify for a commercial loan, lenders will typically look at your credit score, time in business and cash flow history. Additional requirements may apply for different lenders and loan types. For instance, borrowers must pledge assets as collateral for secured loans and small businesses must meet certain size standards for SBA loans.