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How Do Commercial Loans Work? A Guide to Commercial Financing

Updated on:
Content was accurate at the time of publication.

Unlike business loans, which are geared more toward small businesses, commercial loans help larger businesses that need higher loan amounts. They can be used to cover business expenses and operational costs.

Let’s explore how these loans can be a game-changer for your business.

Commercial loans can be used for many purposes, including buying or constructing real estate or purchasing furniture or equipment.

Business owners can also use commercial loans to cover day-to-day business expenses. For example, a commercial loan can support cash flow when income is irregular. The cash infusion provides the funds to pay suppliers, maintain inventory or meet payroll.

Commercial loans vs. business loans

Commercial loans and business loans are similar in that they both support business activities. However, they differ in their scale.

Commercial loans are typically available for larger amounts. They’re better suited to medium and large businesses that need to acquire a new building or heavy equipment and machinery.

Business loans are better suited to smaller enterprises with more modest financing needs. For example, a small business might use a business loan to buy inventory or cover short-term operational costs.

Essentially, the choice between a commercial loan and a business loan hinges on the scale of a business’s financial needs.

Let’s look at some common types of commercial loans and how they’re used.

Commercial real estate loans

Commercial real estate loans are used for purchasing or renovating commercial properties, including owner-occupied commercial real estate and commercial refinance investments.

These loans are ideal for expanding a business’s physical footprint or upgrading existing spaces.

Commercial auto loans

Businesses use commercial auto loans to purchase vehicles (or fleets of vehicles) used for business purposes. This can include heavy trucks, vans, buses and private-passenger vehicles.

Commercial construction loans

Commercial construction loans finance the construction of new buildings or renovations of existing structures. Businesses may use a commercial construction loan to buy land and pay to construct a building, then refinance into a commercial real estate loan once the project is complete.

Commercial bridge loans

Commercial bridge loans are short-term loans that cover immediate expenses while waiting for long-term financing. They’re often used in real estate transactions.

Commercial hard money loans

Commercial hard money loans are short-term, asset-based loans where real estate is collateral. They’re typically quicker to obtain than other types of commercial loans but come with higher interest rates.

Equipment financing

Equipment financing is specifically for purchasing new equipment or machinery. It’s an option for businesses that need to upgrade or expand their operations.

Businesses have various lenders to choose from when looking to secure a commercial loan, including traditional banks, credit unions, lenders backed by the U.S. Small Business Administration (SBA), online lenders and Community Development Financial Institutions (CDFIs).

To help narrow your search, the following table outlines four types of lenders and their maximum loan amounts and minimum credit score requirements.

LenderHighlightsMax. loan amountMin. credit score
A portion of your loan is guaranteed by the SBA, making it easier to qualify for financingUp to $5,500,000 for SBA 504 loansMost SBA lenders require a minimum personal credit score of at least 680See commercial loan offers
A marketplace for many different types of borrowing, including loans, equipment financing, business credit cards and merchant cash advancesUp to $5,000,000600 for equipment financing, 650 for SBA loansSee commercial loan offers
Ideal for established businesses, good credit and the ability to provide collateralUp to $3,000,000Not disclosedSee commercial loan offers
Loans and lines of credit with no hard credit checks for most applicantsUp to $5,000,000 for SBA 7(a) loans660 (650 for SBA 7(a) loans)See commercial loan offers

Understanding the terms, rates and fees associated with commercial loans is crucial for making an informed decision, as they can significantly impact your overall cost of borrowing.

  • Terms: Commercial loan terms typically range from short-term (a couple of years) to long-term (up to 20 or 25 years), depending on the loan type and purpose. Longer terms usually mean lower monthly payments but paying more interest over the life of the loan.
  • Rates: Interest rates on commercial loans can be fixed or variable. Fixed rates remain constant over the life of the loan, while variable rates can fluctuate based on market conditions. Factors like creditworthiness, the loan amount and the economic environment influence rates.
  • Fees: Lenders can charge various fees, including origination fees, legal fees, appraisal fees, prepayment penalties and late payment fees.

Securing a commercial loan requires meeting specific qualification criteria set by lenders. While that criteria varies from lender to lender, here are a few common factors lenders look for.

  Credit score: Your personal and business credit scores give lenders an indication of your history of managing debt and making on-time payments. Many lenders look for scores above 650, but minimum credit scores vary.

  Business plan: A well-structured business plan showcases your business strategy, market analysis and financial projections. Lenders may look at your business plan to assess your business’s future profitability and ability to pay the loan as agreed.

  Annual revenue: Your business’s annual revenue helps lenders gauge its financial stability. Higher revenues typically improve your chances of loan approval and may help you secure better loan terms.

  Time in business: Many lenders prefer to work with companies that have been in business for at least two years, as a longer track record may reduce lending risk.

  Down payment and/or collateral: Certain lenders or loan types may require a down payment or collateral (such as real estate, inventory, receivables or equipment). These reduce the lender’s risk and help you qualify for more favorable loan terms.

Applying for a commercial loan can be long and arduous if you’re unprepared. While the process can vary from lender to lender, here are a few common steps that can help you apply efficiently and improve your chances of securing the best possible terms.

1. Estimate your borrowing power

Assess how much you need to borrow and can realistically afford to repay. Consider your business’s financial health and the purpose of the loan to decide on a sensible loan amount.

2. Evaluate your eligibility

Review the qualification factors, such as your business and personal credit score, annual revenue, time in business and available down payment or collateral. This self-assessment can help you understand your chances of loan approval.

3. Compare commercial lenders

Research various lenders, including banks, credit unions and online lenders. Compare their loan terms, rates, fees and eligibility requirements to find the best fit for your business needs.

4. Gather paperwork and apply

Assemble the necessary documentation, including financial statements, business plans, tax returns, bank statements, and business licenses and formation documents. You will likely need to submit these loan documents with your loan application.

5. Review closing documents

Once your loan application is approved, review the loan’s closing documents carefully. These include the final loan terms, repayment schedule and additional obligations, such as providing annual financial statements or signing a personal guarantee. Ensure you understand all of these aspects before signing.

Several alternatives to commercial loans might be better suited to certain situations. Here are a few to consider.

Small business grants

Small business grants are ideal for businesses seeking funding without the obligation to repay a loan or give up a portion of their equity. They’re often aimed at certain industries or for specific purposes, such as innovation or community projects.

Pros: No repayment required
Cons: Highly competitive

Small business loans

Small business loans are suitable for smaller businesses and startups that don’t require much working capital.

Pros: Easier to qualify for than commercial loans
Cons: Lower borrowing limits

Microloans

Microloans are available in smaller amounts — typically up to $50,000. They’re available to small businesses who might have trouble qualifying for a business loan from a traditional bank.

Pros: Accessible to businesses with limited credit history or collateral
Cons: Limited loan amounts

Business lines of credit

A business line of credit (LOC) is a revolving form of funding that allows businesses to withdraw funds as needed, borrowing up to the credit limit. After repaying the borrowed amount, the business owner can withdraw funds again. LOCs are useful for businesses that need flexible access to funds for ongoing operational costs.

Pros: Pay interest only on the amount used
Cons: Usually come with variable interest rates

Business credit cards

Business credit cards are suitable for short-term financing or managing small, routine expenses.

Pros: Easy to use, can help build business credit and have potential to earn rewards
Cons: May charge high interest rates if balance isn’t paid in full each month

Crowdfunding for business

Crowdfunding allows business owners to pitch an idea, set a fundraising goal and accept donations from the public through an online platform. GoFundMe is an example of a crowdfunding platform.

Crowdfunding can be a good option for businesses with a compelling story or a product that resonates with a wide audience.

Pros: Access to a broad pool of potential investors; doubles as marketing
Cons: May have to offer rewards or incentives to invest; funding isn’t guaranteed

Commercial real estate loans are specifically for purchasing or developing properties used for business purposes. They often require larger down payments than residential loans or mortgages, which are used to purchase owner-occupied housing.

Generally, commercial loan lenders require the business owner to have a good credit score — above 680. However, minimum credit score requirements vary depending on the lender and loan type.

The repayment term for a commercial loan can vary widely, ranging from a few years to 20 to 25 years, depending on the loan type, amount and terms agreed upon with the lender.

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