Commercial Loans: What They Are and How They Work

The terms “commercial loan” and “business loan” are often used interchangeably by lenders. However, some lenders make a distinction between the two, offering business loans to smaller companies and commercial loans to larger entities. Here’s what you need to know before starting to search for commercial funding.

What is a commercial loan?

Commercial loans are a form of debt-based financing used to fund business expenses. Essentially, that means they’re a form of small business funding where you borrow money — usually from a bank or online lender — and repay what you’ve borrowed over time. These funds can be used to cover a variety of business-related costs, from purchasing real estate to paying operating expenses.

Commercial loans vs. business loans

By definition, commercial loans and business loans are the same thing: a form of funding that you borrow from a lender to cover business costs.

However, some lenders use the term “commercial” to refer to larger accounts and “business” to refer to smaller accounts. For example, PNC Bank’s commercial banking division is dedicated to serving businesses that have between $5 million and $50 million in annual revenue. Entities that make less than that are referred to their business banking division.

While every lender sets its own requirements, if a distinction is made, it will likely be reflected in the lender’s borrowing limits and eligibility criteria. As a rule of thumb, commercial lending offers larger loan amounts than small business lending. However, the eligibility criteria you’ll need to meet are also stricter. For instance, you may face a higher annual revenue requirement or a longer time in business requirement.

How commercial loans work

Commercial loans are often structured as term loans, where the lender provides you with a lump sum payment that has to be repaid over time with interest. There are two types of business term loans: short-term business loans, where repayment windows only last for a few months, and long-term business loans, where your repayment term spans over a number of years.

However, commercial loans can also be structured as business lines of credit. Business lines of credit work similarly to business credit cards, where you’re allowed to borrow up to a certain limit and you’ll only pay interest on the borrowed amount. Once you pay down your balance, the limit resets and you can borrow against it again.

Common commercial loan eligibility criteria

No matter which form the funding takes, 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. Plus, bad credit business loans are available.

 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. If your business doesn’t meet that benchmark just yet, consider applying for startup funding instead.

 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.

Types of commercial loans

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

• Commercial real estate loans: Commercial mortgages typically require at least 20% down and may have unusual loan structures such as balloon payments or shorter term lengths.
• Commercial auto loans: Commercial auto loans provide funding for delivery vehicles, employee transportation, hauling customers around and more — either as individual vehicles or as entire fleets.
• Commercial construction loans: As the name suggests, commercial construction loans offer funds available on a draw schedule to pay for construction costs, including land.
• Commercial bridge loans: Bridge loans are 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: Hard money loans are short-term, generally expensive loans based on the value of an asset — usually real estate — rather than the business’s creditworthiness.
• Commercial equipment financing: Equipment financing is funding used to acquire business equipment such as factory or construction equipment. It can be structured as a loan or a lease where the lender retains the title to the asset.

Where to find commercial loans

When you’re ready to find a commercial loan, you’ll have several different options for where to look, including:

Traditional banks

Traditional banks, like PNC Bank or Bank of America, are likely going to be the best fit for businesses with strong financial profiles and well-established operating histories. Out of all the options on this list, they generally offer the most affordable interest rates. However, in exchange, they can impose strict qualifying criteria and have longer funding times than online lenders.

Online lenders

Meanwhile, online lenders, like OnDeck or Funding Circle, offer fast turnaround times and streamlined application processes. In addition, their qualification criteria are generally less strict than those of brick-and-mortar banks. Still, you’ll likely face higher interest rates and pay more overall for the privilege of borrowing.

SBA loans

Many banks and online lenders offer loans backed by the Small Business Administration (SBA), like SBA 7(a) loans and SBA 504 loans. These loans include a guarantee that makes lending less risky for a lender, making it possible for lenders to offer financing to those who may not qualify for more traditional funding. Yet, SBA loans have a lengthy application process and long turnaround times compared to other lenders.

Lending marketplaces

Lending marketplaces, like LendingTree, make it easy to compare loan offers from multiple lenders at once. If you choose to go this route, you’ll fill out one application and receive a variety of offers to choose from. But, you may be limited to offers from a pool of partner lenders and in how much you’re able to borrow.

How to choose a commercial loan

Before you apply for a business loan, it’s smart to compare different lenders. Here are a few metrics you may want to consider to ensure an apples-to-apples comparison.

• Terms: As explained above, commercial loan terms can be either short-term or long-term, depending on the loan type and purpose. Longer terms usually mean lower monthly payments but more interest paid over the life of the loan. Shorter terms often mean a higher monthly payment with less interest paid overall.
• Rates: Commercial loan interest rates 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, loan amount and the economic environment influence rates. Some lenders may also charge a factor rate instead of simple interest.
• Fees: Lenders can charge various fees, including origination fees, legal fees, appraisal fees, prepayment penalties and late payment fees.
• Funding time: Some lenders have the capacity to offer same-day funding, while others may take a few days or even weeks to fund your loan request.

How to apply for a commercial loan

Applying for a commercial loan is no different than applying for another business loan. While the process can vary from lender to lender, here’s an overview of what to expect.

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

Business loan interest rates can vary according to market rates and the lender’s estimation of your creditworthiness, which means that you can apply with two different lenders and get a vastly different loan offer from each one. As a result, it’s a good idea to compare loan offers and shop around for the best rate before you officially apply for a business loan.

To compare quotes, you can either go directly to lenders and get quotes through each website or use a loan marketplace like LendingTree to get multiple quotes at once.

As you compare them, be sure to look at the loan terms holistically rather than just focusing on the interest rate. Consider all the criteria mentioned above, like added fees and funding times, to ensure that you select the loan offer that best suits your business’s 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 supporting documents alongside 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

If getting a commercial loan isn’t the right choice for your business, here are a few alternative financing options to consider:

Small business grants

 Pros: No repayment required

 Cons: 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.

Microloans

 Pros: Accessible to businesses with limited credit history or collateral

 Cons: Limited loan amounts

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

Business credit cards

 Pros: Easy to use; can help build business credit and have the potential to earn rewards

 Cons: 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.