How Do Commercial Loans Work? A Guide to Commercial Financing
The terms “commercial loan” and “business loan” are used interchangeably by many lenders. However, some lenders make a distinction between the two, targeting small business loans at smaller or newer businesses, and commercial loans at larger and more well-established businesses. Commercial loans can be used to cover business expenses and operational costs.
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What are commercial loans used for?
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
Some lenders use the term “commercial loans” to refer to larger business loans, although in general, most lenders don’t differentiate between the two. You may be able to borrow up to $5 million with an SBA 504 “business loan,” for example, while Bank of America underwrites “commercial real estate loans” as small as $25,000.
Each lender sets its own requirements, rates and funding amounts. If a particular lender does make a distinction between business loans and commercial loans, that might be reflected in annual revenue or time in business. For example, a commercial loan might require a longer time in business or a higher annual revenue to support paying back a larger loan. A business loan, however, might have a lower qualification threshold for these criteria.
Types of commercial loans
Let’s look at some common types of commercial loans and how they’re used.
- Commercial real estate loans: Typically requires at least 20% down and may have unusual loan structures such as balloon payments or shorter term lengths.
- Commercial auto loans: Funding for delivery vehicles, employee transportation, hauling customers around, and more — either as individual vehicles or as entire fleets.
- Commercial construction loans: Funds available on a draw schedule to pay for construction costs, including land.
- Commercial bridge loans: Short-term loans designed to cover gaps between paying for high-value business assets, like real estate, and securing long-term funding.
- Commercial hard money loans: Short-term, very expensive loans based on the value of an asset — usually real estate — rather than the business’s creditworthiness.
- Commercial equipment financing: Funding used to acquire business equipment such as factory or construction equipment (can be structured as a loan or a lease where the lender retains the title to the asset).
Residential vs. commercial real estate loans
Most people are familiar with the residential mortgages they take out for their home. Here’s how they compare to commercial real estate loans:
| Residential real estate loan | Commercial real estate loan |
|---|---|
| Qualify with personal credit | Qualify with business and personal credit |
| 15- or 30-year loans, typically | 5- to 25-year loans |
| Generally fully amortizing | May or may not be fully amortizing; if not, may require a balloon payment at end of term |
| Flexible options for down payment | Requires 20% down payment or more |
If you have a home-based business, like an in-home daycare or a room set aside for meeting with clients, you may not need a business real estate loan; a residential mortgage may be enough. Check with your lender to be sure.
Where to get a commercial loan
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 options for commercial loans and their maximum loan amounts and minimum credit score requirements.
| Lender | How it works | Max. loan amount | Min. credit score | |
|---|---|---|---|---|
 | Specific lenders offer these loans at lower rates by partnering with the SBA to guarantee a portion of your loan. | Up to $5,500,000 for SBA 504 loans | Most SBA lenders require a minimum personal credit score of at least 680 | See commercial loan offers |
 | FinanceFactory works with a network of lenders to offer different funding solutions to match your business needs. | Up to $5,000,000 | 600 | See commercial loan offers |
 | This bank offers commercial loans to well-qualified businesses. | Up to $3,000,000 | Not disclosed | See commercial loan offers |
 | This online lender offers commercial loans with no hard personal credit check. | Up to $500,000 for SBA 7(a) loans | 660 (650 for SBA 7(a) loans) | See commercial loan offers |
Terms, rates and fees
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 more interest paid 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.
Eligibility requirements
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.
4 things to know about commercial loans before applying
Commercial loans aren’t governed by consumer protection laws that help standardize consumer loans. As such, they can vary tremendously, and that means you need to pay careful attention to how they work.
- Not all loans are assumable, However, some loans are — such as SBA 504 loans, if you decide to sell your business, for example. An assumable loan is any loan that allows you to sign over the mortgage to a new owner if you sell your company.
- Lenders can sell your loan. Many lenders sell your loan to other companies as an investment, meaning your lender may change. If your loan is sold, you’ll receive a notice with all the relevant information, including if you need to change who you make payments to or how.
- Refinancing is possible. If your current commercial loan isn’t working out for your business or you think you may be eligible for a better interest rate, then it’s possible to get a commercial refinance loan.
- May require a personal guarantee. Many lenders require you to essentially co-sign on your loan so that if your business goes under, you’ll have to personally repay it.
How to apply for a commercial loan
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.
Alternatives to commercial loans
Several alternatives to commercial loans might be better suited to certain situations. Here are a few to consider.
Small business grants
Pro: No repayment required
Con: Highly competitive
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.
Small business loans
Pro: Easier to qualify for than commercial loans
Con: Lower borrowing limits
Small business loans are suitable for smaller businesses and startups that don’t require much working capital.
Microloans
Pro: Accessible to businesses with limited credit history or collateral
Con: Limited loan amounts
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.
Business lines of credit
Pro: Pay interest only on the amount used
Con: Usually come with variable interest rates
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 a type of working capital loan useful for businesses that need flexible access to funds for ongoing operational costs.
Business credit cards
Pros: Easy to use; can help build business credit and have potential to earn rewards
Con: May charge high interest rates if balance isn’t paid in full each month
Business credit cards are suitable for short-term financing or managing small, routine expenses.
Crowdfunding for business
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
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.