Commercial Loans: Types, Rates, And Where To Find The Best
Have you seen the term “commercial loans” in an ad from a bank or alternative lender and wondered what, exactly, that meant? Or where you’d look for one? Or what the terms of a commercial loan might be?
We’re here to help!
Table of Contents
- What Are Commercial Loans?
- Who Offers Commercial Loans?
- What Types Of Commercial Loans Are Available?
- Qualifying For A Commercial Loan
- What To Look For In A Commercial Loan
- Commercial Lenders
What Are Commercial Loans?
A commercial loan is simply a financial agreement made between a financial institution or private lender and a business (as opposed to an individual) where the business takes on debt in exchange for capital. This money can then be used for business expenses, inventory, or operating costs. Though individual institutions may use the phrase a little differently, commercial loan is more or less a synonym for “business loan.”
Commercial loans aren’t specific types of loans but are rather a category of loans or loan-like products that lenders offer to businesses.
Who Offers Commercial Loans?
While they’re not the only game in town anymore, banks are still one of the best sources of lending available to businesses that fall within their territory. Lending standards are still fairly tight compared to those before the 2008 financial crisis, however, so bank loans may be out of reach for newer businesses or those with bad credit. Still, if you’re looking for the most competitive rates, you’ll probably find them at a bank.
Filling the niche missed by traditional lending institutions is the private, alternative lending market. These lenders tend to have easier qualifications and quicker applications. Additionally, most have more of a national focus, which is helpful if your business is located in an underserved area. The trade-off is usually, though not always, higher rates and stricter repayment regimens since these loans represent investment opportunities in the form of private capital rather than banking services.
What Types Of Commercial Loans Are Available?
This is where it gets interesting and more complex. If you’re entering the market just looking for a “loan” you may quickly be overwhelmed by the terminology, buzzwords, and marketing gimmicks. On top of that, individual lenders will brand their financial products, making it harder to make a 1:1 comparison between different company’s offerings.
The good news is, once you cut away all the gimmicks, there aren’t that many different types of products to wrap your head around.
Sometimes called medium or long-term loans, term loans what most people think of when they hear the word “loan.” In most cases, a business that successfully applies for a term loan will receive a lump sum of cash which can then be used for business expenses. In some cases, there may be restrictions on what the money can be used for. These loans will generally last between one and 10 years, accruing interest along the way. The longer the term, the more expensive the loan will be.
In most cases, you’ll make fixed, monthly payments to your lender. The loan is considered paid off when you’ve paid back the money you’ve borrowed plus interest.
Isn’t a short-term loan just another type of term loan? You’d think so, but short-term loans are actually pretty different than their medium- and long-term cousins. Short-term loans don’t last that long, as the name would suggest — usually less than a year — so they don’t have time to accumulate a lot of interest. Because of that, most short-term loans charge a flat fee rather than a true interest rate. This flat fee may be expressed as a percentage (18%) or as a multiplier (1.18). In either case, to figure out how much your flat fee is in dollars, simply multiply that number by the amount you’re borrowing.
Short-term loans are both faster and more expensive than other term loans, featuring expedited application processes. Unfortunately, your repayments are also sped up, with fixed payments made weekly or even daily. These payments are almost always automatically deducted from your bank account. As in the case of term loans, these payments are fixed (with some rare exceptions).
The Small Business Administration (SBA) is a federal agency tasked with promoting and assisting American small businesses. The term SBA loan is a little bit misleading because the SBA doesn’t usually originate their own loans. Instead, they work through banks and privates lenders, guaranteeing a percentage of the borrower’s debt. This reduces the risk to the lender and allows businesses to qualify for rates and terms they may otherwise be unable to get.
The two most popular programs are the SBA 7(a) and the CDC/504. The 7(a) loan is the more popular of the two. It covers typical working capital expenses as well as site improvements and business acquisitions. 504 loans are oriented more around economic development.
The major drawback to SBA loans is that they have a longer and more complicated application process than similar term loans. While SBA Express loans speed up the process a bit, don’t expect to have the money in your account right away.
If you plan on buying equipment with your loan, you may want to consider an equipment loan. Equipment loans look a lot like term loans, but rather than being open-ended are specifically used to cover a percentage (85% is typical) of the cost of a specific piece of equipment.
Why would you want this?
Equipment loans use the equipment you’re purchasing as collateral, meaning you get the benefits (lower rates, longer terms) of a secured loan without putting up any of your own assets.
Lines Of Credit
Not sure how much money you’ll need in the coming year? Do you anticipate needing to make a large number of small purchases over a period of time? Do you just want to have something to fall back on in an emergency?
When you get a business line of credit, your company is approved up to a certain credit limit (a line of credit is very similar to a business credit card in that respect). Let’s say you’re approved for $100,000. You can draw upon that line of credit any number of times, in any amount you want, until you’ve accumulated $100,000 worth of debt. You only pay interest on the amount of credit you’ve used. This makes lines of credit far more versatile than other types of loans.
If the line of credit is revolving, any balance you pay off becomes available for use again. If it’s a non-revolving line of credit, it’s a one-shot deal. You can still withdraw in increments, but once the credit is used, it won’t become available again.
This convenience tends to come at a premium. Lines of credit usually have higher qualifications than loans, and many come with annual or even draw fees. They usually feature variable monthly payments, although some offer no-interest grace periods.
These products aren’t loans, commercial or otherwise, but you’re probably going to run into them if you’re looking for commercial loans. Here’s a quick rundown so you won’t be caught off-guard.
Merchant cash advances (MCAs) are an alternative way to get working capital. Rather than lending you money, the funder buys a percentage of your future credit/debit card sales. MCAs fill a similar niche to short-term loans. You’ll still get a lump sum, be charged a flat fee, and make daily payments. But rather than imposing fixed payments, your funder will claim a percentage of your daily card sales. Because MCAs aren’t loans, they aren’t governed by laws affecting loans. This allows them to be offered to riskier “borrowers,” and at a higher rate.
Capital leases are an alternative to equipment loans. Though the word “lease” suggests renting, they’re actually designed with ownership in mind. In exchange for a higher interest rate, you’ll get the full cost of the equipment covered. Like you would with a term loan, you’ll pay a capital lease off monthly. At the end of the lease, there will be a small remainder (as low as a $1) you’ll need to pay to close the transaction. This is called a “residual.”
Invoice factoring is a way to get an advance on your accounts receivable by selling them to a factoring company at a small loss. That company then collects on the invoice in your place. You’ll be paid the majority of the invoice’s value as a lump sum up front, with the remainder paid out to you — minus a fee — when (and if) the factoring company collects on the invoice.
Qualifying For A Commercial Loan
An easy way to narrow down your options is to eliminate any options for which you do not qualify. This will save you time and, potentially, money. Qualifications will vary from lender to lender, but these are the main things you’ll want to consider.
There’s no way to completely get around it: your credit rating matters when you’re looking for financing. The question is “how much does it matter?”
For the more conservative lenders, your credit rating is a line in the sand. If you don’t meet their minimum standard, they simply won’t work with you. For traditional banks and SBA loans, that line is usually somewhere in the mid-to-high 600s.
With alternative lending, the guidelines aren’t so hard and fast. Some lenders impose minimums below which they absolutely will not go, but others don’t use credit scores for rule-out criteria.
That said, pretty much every lender, traditional or alternative, will use your credit history to determine what kind of rates you’re offered.
Time In Business
Lenders are going to want to know that your business is real and has staying power. A business that’s been afloat for five years inspires more confidence that one that is three months out from opening.
That said, not everyone is looking for the same thing. A traditional bank may want to see two to three years in business before they’re willing to take a risk on you. An online short-term lender may only be looking for six months — or even three months, in some cases.
Any reasonable lender is going to want to know that you’re capable of paying them back. Even alternative lenders with loose credit prerequisites, especially those dealing in unsecured loans, will want to see your bank statements to get a sense of your cash flow. The more revenue you regularly take in, the more credit your prospective lender will be willing to extend you.
Location & Industry
This one’s out of your control, but the lender you’re looking at may not lend to businesses in your industry or even to your state. Banks tend to lend mainly through their physical branches and may require you to have a business checking account with them. Alternative lenders operate primarily online, but due to differences in lending regulations between states may not be able to lend to you, or may not be able to offer all their products.
If you’re seeking a secured loan or line of credit, you’ll need to be able to put up collateral to secure your funding. What qualifies as collateral varies between lender and product, ranging from cash deposits to inventory, equipment, or real estate. Make sure you can put up the necessary collateral.
What To Look For In A Commercial Loan
Qualifying isn’t enough. It’s important that a lender meets your standards as well. So what should you look for?
Most lenders have minimum and maximum amounts they’re willing to lend to businesses. You’ll want to be certain the lender is capable of giving you the lump sum you’re seeking. Of course, your revenue will have to be sufficient to cover your debt.
Banks are capable of offering larger amounts of money than most alternative lenders. One of the easier ways for a small business to qualify large amounts of money is through an SBA loan.
How long do you need to pay your loan off? This can be a complex question; there’s no “right” answer. For any individual product, a shorter term length usually means lower interest rates than a longer one. However, paying off a loan quickly may stress your cash flow in the short-term. Having a good sense of your business’s ebb and flow before applying for any financing.
But don’t make the mistake of thinking short-term lending products come with lower interest rates or fees than long-term loans. In fact, those products tend to be among the most expensive in the industry. That said, the speed with which short-term lenders or merchant cash advance providers can get money into your hands may make them the best choice if you have time-sensitive expenses.
It goes without saying that you want to get the lowest rate you can whenever you borrow money.
APRs serve as one of the easiest ways to make direct comparisons between different products. Even though short-term loans use flat fees rather than interest rates, there are tools available to help you make the conversion.
Remember that lenders don’t always mean the same thing when they say “interest.” The percentage you see may be annual or monthly. In some cases, a flat fee may even be described as an interest rate.
Not to be confused with interest rates or flat fees, these are costs associated with the loan beyond interest rates. Not all lenders charge fees for every product, and some may have promotions that waive fees.
The most common fee you’re likely to encounter is the origination fee. Usually ranging between 1% – 4% of the amount of money you’re borrowing, this is not a fee you pay out of pocket. Instead, it is deducted from the lump sum you receive from the lender, so you’ll want to take it into account if you’re counting on every cent.
Additional fees may be charged for setting up accounts from which to withdraw automated payments, for late payments, or even just miscellaneous “administration fees.” Approach any lender who charges anything beyond an origination fee with caution and factor those costs into the amount of debt you’re taking on.
Hopefully, we’ve answered some basic, nagging questions about what commercial loans are and how they work. With so many potential options, finding a lender can be an overwhelming prospect. Not sure where to look? We can help get you started.
|Loan Type||What It Is||Typical Rates||Learn More|
Traditional Term Loans
Loans in which you borrow money in one lump sum and repay in fixed installments. Term loans can be used for most business loan purposes.
4% - 36% APR
Small Business Administration (SBA) Loans
Loans offered by the SBA in partnership with banks and other financers. SBA loans are backed by an SBA guarantee and originated by banks and other partners.
6% - 12% APR
Commercial Real Estate Loans
Loans used to finance the purchase or commercial real estate.
4% - 36% APR
Business Lines of Credit
Credit lines used for business purposes. Borrowers can draw from their credit line at any time and only pay interest on the amount borrowed.
8% - 65% APR
Business financing with short term lengths, which normally have a one-time fixed fee instead of interest.
8% - 99% APR
Loans used to finance the costs of starting a business.
4% - 36% APR
Loans used to purchase equipment. The purchased equipment is normally used as collateral to back the loan.
5% - 24% APR