How Do Commercial Loans Work? A Guide to Commercial Financing

Commercial loans are a type of funding meant to cover business expenses. Unlike business loans, which help small business owners, commercial loans are typically geared toward larger businesses that need higher loan amounts. Here’s what you need to know about this common business financing method.

What is a commercial loan?

A commercial loan is a debt-based funding arrangement between a lender and a business entity. In particular, these loans are often made to larger business entities seeking higher loan amounts.

The funds are typically used to fund the purchase of assets, such as real estate or equipment. However, these loans can also be used to fund the business’s day-to-day operations.

How do commercial loans work?

There are several different types of commercial loans (more on that below) you can use for different business needs. Still, as a rule of thumb, commercial loans are typically term loans, meaning that they’re repaid in regular installments over a set period of time.

The rates, fees and specific repayment terms that you’re offered will vary by lender and loan type. But in order to give you a better idea of what to expect, we’ve compared and contrasted them with two other commonly used forms of financing.

Commercial loans vs. business loans

Commercial loans and business loans are both used to finance business expenses. However, the financial industry typically uses the name “commercial loans” for corporations and larger business entities seeking higher loan amounts. The term “business loan” or small business loans are more commonly reserved for smaller-sized businesses.

Commercial real estate loans vs. residential loans

Commercial real estate loans and residential mortgages are both used to fund real estate purchases, but here’s a closer look at how they differ:

Types of commercial loans

There are a few different types of commercial loans to choose from and some are meant for a specific purpose. Here’s an overview of what to expect:

  Commercial real estate loans: Similar to residential mortgages, these loans can help you buy, develop, or renovate real estate. However, the funds must be used on an income-producing property rather than a personal residence.

  Commercial auto loans: Like personal auto loans, commercial auto loans can be used to purchase vehicles.

  Commercial construction loans: Commercial construction loans are used to help you build new income-producing properties from the ground up.

  Commercial bridge loans: As the name suggests, bridge loans are a type of short-term financing that can be used to cover expenses until you can get a more permanent source of funding.

  Commercial hard money loans: Hard money loans are a short-term form of commercial real estate financing. They’re typically used by business owners who are unable to qualify for more traditional forms of funding.

  Equipment financing: As you might be able to guess, equipment financing is used to purchase business equipment.

Where to get a commercial loan

Now that you know more about the different types of commercial loans that are available to you, it’s time to learn where you can get one. You’ll likely end up applying at one of the following three places.

Banks or credit unions

Traditional lenders, like banks or credit unions, are attractive to many businesses because they tend to offer some of the best business loan interest rates, which can make borrowing more affordable. However, in exchange, they also tend to have a longer application process and stricter qualifying criteria than other lenders.

Typically, you’ll need to have at least a two-year business history, collateral and consistent revenue to qualify.

U.S. Small Business Administration

The U.S. Small Business Administration (SBA) also offers some commercial loans. In particular, the SBA 504 loan can be used to purchase commercial real estate and for heavy equipment financing.

While the SBA offers large loan amounts with comparatively low interest rates, its application process is more involved and its funding times are longer. In addition, borrowers will have to meet the SBA size requirements in order to qualify.

Online lenders

Online lenders, also called alternative or nontraditional lenders, use digital underwriting software to help them make their loan decisions. As a result, their qualifying requirements tend to be more flexible than traditional lenders and they have the capability to deliver a decision much faster.

That said, online lenders tend to offer much higher interest rates than their brick-and-mortar counterparts.

How to apply for a commercial real estate loan

1. Estimate your borrowing power

If you’re thinking about applying for a commercial loan, one of the first things you’ll want to do is estimate how much you can afford to borrow. After all, the last thing that anyone wants is to take out a loan that they can’t comfortably afford.

Use our business loan calculator to help estimate how much you may be able to borrow. Then, compare that figure to how much you need for your expenses.

2. Evaluate your eligibility

Once you have a better idea of how much you might want to borrow, it’s time to look at your ability to be approved for a loan. Lenders typically look at your credit score — both business credit score and personal — along with taking a look at your business’s cash flow and debts to determine your ability to repay the loan.

In particular, lenders are likely to look at the following factors:

• Debt service ability
• Income and expense trends
• Balance sheet, including debt-to-worth ratio
• Borrower payment history
• Overall financial performance

The stronger each of these factors is, the more likely you are to be approved for a loan.

3. Shop around for a lender

After you’ve made sure your business’s financials are in good shape, the next step is to shop around for a loan. Shopping around can help you save money on interest charges and help ensure that you choose the loan terms that are the best fit for you.

As a general rule, you’ll want to compare the following features:

• Potential loan amount
• Estimated interest rate and fees
• Length of the loan
• Application speed and funding time
• Lender reputation

4. Apply for a loan

Once you’ve compared loan offers and selected the best option for you, the next step is to apply for the loan. Many online lenders will let you fill out your application digitally. However, if you decide to go the traditional lender route, you’ll likely have to visit a branch in person to apply.

In either case, be prepared to provide the lender with some supplemental documentation alongside the application itself. Providing the lender with documents like a recent copy of your business plan, any applicable business licenses and current financial statements will be a key part of obtaining loan approval.

If you need help pulling all the pieces together, consider visiting your local small business development center (SBDC) for assistance.

5. Close on the loan

After you receive final loan approval, review the proposed loan agreement carefully. Be sure to reach out to the lender if you have any questions or concerns about the terms of your loan. Once you’re satisfied that you understand the repayment terms and any applicable fees, sign on the dotted line.

Alternatives to commercial loans

Commercial loans are just one type of business loan and they have a few very specific purposes. With that in mind, if you need to cover business expenses that aren’t related to one of the uses described above, you’ll need to consider other methods of financing. Here are a few options:

• Small business grants: Small business grants are essentially money for your business that doesn’t have to be repaid. They are available on federal, state and local levels. However, you have to apply and be approved in order to receive the funds, and the competition can be stiff.
• Business loans: Business loans, also known as “small business loans,” are typically reserved for smaller business entities. There are two main types of business loans, short-term business loans, which have loan terms ranging up to 24 months, and long-term business loans, for which the loan term extends up to 10 years.
• Microloans: If you only need to borrow a small amount, you may want to consider microloans. As the name suggests, these loans come in smaller loan amounts, usually up to $50,000. They can be a good option for businesses that don’t qualify for traditional bank financing.
• Business lines of credit: Rather than having funds disbursed in a lump sum, a business line of credit works like a credit card, allowing you to draw funds as needed.
• Business credit cards: Like personal credit cards, business credit cards are a type of revolving funding that you can use as needed. This type of funding typically works best for small, recurring expenses, such as inventory or utilities. Just make sure to pay off the statement in full each billing cycle to avoid the typically high APRs.