Commercial Loans: What They Are & How They Work

IN THIS GUIDE

Commercial loans help business owners and real estate investors make large purchases or fund operations. There are several types of commercial loans, and most are available through traditional banks and online lenders. Rates, loan amounts, and terms vary by financial institution, but borrowers can generally access up to 75% to 80% of project costs, at rates starting at 3% to 4%. 

What Is a Commercial Loan?

A commercial loan is a type of funding offered to businesses through traditional banks and online lenders. Commercial loans are most commonly used to pay for major capital expenses and to cover operational costs. This type of financing is often secured by specific collateral —such as real estate or machinery—although this is not always the case. 

 

Business owners can typically choose from products like conventional term loans, business lines of credit, as well as commercial real estate loans (CREs) that finance the purchase of commercial properties like office buildings, manufacturing facilities, and shopping centers.

How Do Commercial Loans Work?

Commercial loans are extended by traditional banks, credit unions, and other financial institutions, as well as by online lenders. The application process for commercial loans varies by lender, but it typically involves providing documentation of the business owner’s personal finances and business finances. 

 

Depending on the borrower’s needs and creditworthiness, commercial loan amounts can vary from several thousands of dollars up to several millions of dollars. Annual percentage rates (APRs) start at 3% or 4% and go up to 20% or higher, depending on the loan type and the borrower’s credit history.  

 

Once a commercial loan is approved, funds are disbursed to the business account and interest begins to accrue at the agreed rate. Payments are made monthly for a set loan term—typically up to five or 10 years, but this number can be up to 20 or 25 years for some federally insured programs like those backed by the Small Business Administration (SBA). 

 

Unlike traditional term loans, commercial loans are often not fully amortized, which means that a loan may have a five- or 10-year term, but have a 25-year amortization schedule. This results in a balloon payment that must be paid in full or refinanced at the end of the loan term.

Types of Commercial Loans

Depending on your line of business, you may think of commercial real estate loans or bridge financing as the most common type of commercial loans. However, there are actually a number of commercial lending options designed to fit various borrowing needs. Each type of commercial loan comes with its own qualification, approval, and funding processes, as well as unique interest rates and loan to value (LTV) ratios

Commercial Loan Rates

Loan TypeAverage RatesAverage LTV Ratio
Traditional Bank Loans5% to 7%80%
Commercial Real Estate Loans3.77% and up66% to 73%
Commercial Construction Loans4.75% to 9.75%75%
Bridge Loans4.20% to 12.20%80%
Hard Money Loans10% to 18%60% to 80%
SBA 504 Loan2.231% to 2.399%90%

 

These are some of the most common types of commercial loans:

Term Loans

Term loans are traditional loans with a fixed term—or payment schedule. These loans can be short-, intermediate-, or long-term with repayment extending from three months to 10 years. Once funds are disbursed, borrowers make monthly or quarterly payments that are composed of both principal and interest. Annual percentage rates may be fixed or flexible, but usually start around 9%, with loan amounts as large as $500,000.

Commercial Real Estate Loans

Commercial real estate loans are loans secured by commercial property. These loans can be used to acquire, renovate, demolish, or otherwise invest in commercial real estate. Properties can take the form of offices, stores, hotels, or any other property operated for commercial purposes.

Commercial Construction Loans

Commercial construction loans are ideal for businesses that want to build or significantly renovate a commercial property for their own purposes. These loans are often structured with an initial draw period, during which business owners or their contractors can gradually withdraw money as work is completed. When construction is complete the loan converts to fixed-rate term financing.

Bridge Loans

A bridge loan is a type of high-interest, temporary financing with loan terms usually limited from six to 12 months. In general, bridge loans are used to help a business owner close a deal before they’re able to secure long-term, fixed-rate financing. These loans are ideal when a deal has to close quickly or a business owner needs to sell or refinance other assets before securing long-term financing.

Business Lines of Credit

A business line of credit is a form of business financing that can be accessed on an as-needed basis. Annual percentage rates range anywhere from 10% to 99% and borrowing limits extend from about $2,000 to $250,000. In contrast to a traditional commercial loan, a business line of credit is used on a revolving basis, and interest is only paid on the portion of the credit line being accessed—or what the borrower actually uses. 

 

With this type of financing, a business owner can access a line of credit until the draw period—typically as long as five years—is over. If the business owner repays a portion of what they’ve drawn against the line of credit, they can access those funds again. After the draw period, the repayment period begins, and the borrower must make monthly payments on the outstanding balance, including interest.

Equipment Financing

Business owners who need to purchase large equipment or machinery may benefit from equipment financing. This type of commercial loan can also be used to purchase smaller items like office furniture and electronics and is secured by the underlying collateral—the items purchased with the loan funds. 

 

Equipment loan amounts vary based on the items being purchased but tend to range up to $1 million or higher. Interest rates vary by lender and borrower creditworthiness, but are often lower than some other forms of financing and extend from around 8% up to 30%. Terms are also flexible and can range up to 25 years. 

SBA Loans

SBA loans are business loans issued by banks and backed by the U.S. Small Business Administration, and collectively refer to several programs, including SBA 504, SBA 7(a), and Microloans. Depending on the type of SBA loan, available amounts can range anywhere from $30,000 up to $5 million, and repayment terms may extend up to 25 years. 

 

As with other loans guaranteed by the government, SBA loans offer low-interest rates and less rigorous qualification requirements than financing from private lenders. However, there is also a guarantee fee levied on the portion of the loan insured by the SBA, so this can increase the overall cost of borrowing. 

Pros and Cons of Commercial Loans

Pros

  • Provide access to flexible funds for the purchase of real estate, equipment, and other business assets
  • Interest rates are generally lower than for other types of financing 
  • Loan terms often range up to 10 years or more
  • Available loan amounts are higher than for personal loans
  • Maybe unsecured so valuable business assets are not required to qualify
  • Do not require handing over a portion of company ownership in exchange for funds

Cons

  • It may be difficult to qualify for commercial loans—especially for new business owners without established business credit
  • Application and approval processes are more rigorous than for personal loans and some other types of business financing
  • Some commercial loans require business owners to detail how the funds will be spent
  • Collateral may be required for secured commercial loans
  • Most commercial loans require personal guarantees from business owners

Alternatives to Commercial Loans

Commercial loans come in numerous forms meant to address a range of financing needs. However, these more traditional borrowing options may not be suitable for some businesses, especially those without established credit. If you struggle to qualify for a standard commercial loan, consider one of these alternatives:

 

  • Asset-based lending. Asset-based lending is a type of business loan that’s secured by a valuable piece of the business’ collateral. Asset-based financing that lets real estate investors, developers, and other business owners purchase real estate without qualifying for a traditional mortgage or waiting on a potentially extended application and approval process. 

 

  • Invoice financing or factoring. Invoice financing and factoring are both ways for companies to access cash that they’re owed on invoices more quickly than waiting for clients to pay. With invoice factoring, the borrower effectively sells the invoice to the factoring company, which then assumes responsibility for collections. Invoice financing functions more like a normal loan but is secured by specific invoices.

 

  • Merchant cash advance. A merchant cash advance is a way for businesses that accept credit cards (like stores) to access cash quickly without having to apply for a traditional commercial loan. With this type of loan, a business owner grants a lender—typically a merchant services company—a portion of future sales receipts in exchange for a lump sum of cash. The cash payment is then repaid via automatic clearing house (ACH) payments or from the business’ sales over time. Merchant cash advances typically come with a factor rate between 1.2 and 1.5. 

 

  • Equity financing. Equity financing is the process of raising money from investors, rather than borrowing it from a bank or other commercial lender. Business owners don’t have to pay interest on equity financing, but it does require giving up partial ownership in the company in exchange for receiving the funds. 

Bottom Line

A commercial loan can help you access the funding you need, whether you’re financing a new office building or borrowing money to sustain your business’s day-to-day operations. Because commercial loans are so flexible, there are a number of different options to consider—and some notable alternatives. Make sure you understand all of your options as well as the pros and cons of commercial loans before you commit to financing for your business.  

 

Are you looking for a commercial loan to start or grow your business? One of our reps would be happy to explain how we can help you get the cash you need to take your business to the next level.

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