How Do Commercial Loans Work? - Heartland Financial Group

How Do Commercial Loans Work?

How do commercial loans work? There are a few different types of loans, for those with different needs and goals. Read on to learn about the specific options available.

Most businesses need some windfall to get off the ground. It’s costly to start a company. There are manufacturing and logistic costs. There are storage costs. Payrolls. Administrative costs and paperwork. Not to mention countless hours that will go largely unpaid if you’re building your own business.

Very few businesses have the pleasure or the opportunity to get invited to Shark Tank and take on a massive loan from a private investor. Most other companies need to go through the usual channels to seek funding – and get commercial loans. So how do commercial loans work?

Like any other kind of loan, a commercial loan involves receiving money now in exchange for payment later. The profit motive for any lender is that they will be receiving something in return for the loan. In most cases, it is interest on every payment during the loan’s amortization period. In some cases, loans may be repaid through something more immaterial and intangible, like equity or stock.  

What is a Commercial Loan? 

Commercial loans are business loans, and taking out a commercial loan means borrowing money explicitly to fund your business. This might not necessarily mean you’re taking out a loan for startup costs specifically. Commercial loans can range from taking out a loan for a company car to repairing commercial property.

You can also take out a commercial loan that does not solely involve money. For example, equipment leasing and lending is also a type of commercial loan. In this case, you’re receiving equipment from a lender in exchange for a down payment and monthly payments with interest.

Commercial loans can be obtained from many different lenders. Some of them are banks, while others are lending companies and financial institutions. The government also provides business loans under certain circumstances. During the height of the pandemic, for example, companies were given government aid to encourage them to keep their employees and avoid layoffs and survive the effects of government-mandated social distancing and curfews.

Not all commercial loans are created equal. There is a loan for any given type of situation or company. A small business might not necessarily go through the same steps to take a loan as an established company with a diversified asset portfolio, publicly traded stocks and a long list of relationships with various vendors and lending bodies.

Types of Commercial Loans

All business loans generally exist to provide upfront cash and liquidity to a company for various reasons.

Some companies take out a loan to survive scaling up, as their means of production fail to keep up with growing demands.

Other companies need to take out a loan based on accounts receivable due to stalled client payments.

In many cases, businesses that rely on seasonal revenue may take out a loan during the off-season to finance their production and maintenance costs and pay it back during their peak weeks.

Let’s cover the most important commercial loans, how they work, and their role for different companies.

SBA Loans

Small Business Administration loans are loans devised and authorized by the SBA and provided through a list of accredited and approved lenders. With these loans, the government sets the guidelines and rules for how the loans are structured, but the money is still coming from private banks and financial institutions.

The most popular SBA loans are the SBA 7(a) loan program and the 504/CDC loan program.

An SBA 7(a) loan is a basic term loan providing flexible working capital for a business to invest in inventory, equipment, or anything else. SBA 7(a) loans invested into anything other than real estate have an average term length of 10 years, while SBA 7(a) loans for real estate can have terms as long as 25 years.

504/CBC loan is a much more specific commercial loan provided by CDCs (certified development companies) for the use of renovating existing commercial facilities, purchasing long-term equipment, refinancing renovation debt, purchasing or improving commercial land, building a new commercial property, or purchasing an already existing commercial building.

SBA loan rates depend on term lengths and amounts.

Business Line of Credit

In general, SBA term loans and term loans provide a lump sum for businesses to invest immediately. A line of credit, on the other hand, acts similar to a personal credit card. You have a specific draw limit, need to make monthly payments on your due balance, and have an interest rate based on what you have already spent.

A line of credit can be better for businesses looking to build a long-term financial relationship with a lender who needs financial assistance to acquire inventory or make up for their seasonal schedule without the need for a lump sum. This allows the business to manage their payments better and make up for cash flow problems or other disruptions.

Vendor Credit

Vendor credit effectively allows you to purchase items or procure services from a specific vendor on credit. This means that the vendor renders their services and gives you a short-term deadline to pay off your due balance plus interest (anywhere from 30 to 90 days, usually), with incentives such as discounts for making early payments.

Vendor credit is helpful for any company that specializes in a quick turnaround. This means you can turn the materials or goods you acquire into revenue within the term limit. This also means that you can pay the vendor back what is owed without eating into your working capital. While it is a calculated risk, it allows you to free up that capital to be invested elsewhere.

Commercial Mortgage Loans

commercial mortgage loan is used to purchase income-producing commercial property. This includes apartments, hotels, storefronts, office spaces, and more.

Most commercial mortgage loans only cover the cost of the commercial property itself and not the upfront fees with acquiring it. They also often require a substantial down payment on the property.

When Are Commercial Loans Best Used? 

Each commercial loan has its respective time to shine. Loans can be used to secure your business against slow trade and poor cash flow or make the most of your high revenue by accelerating the pace at which you can scale your business, cutting into new markets, and meeting consumer demands.

The flexibility of a commercial loan is key to its importance in the world of business management – any business owner with their eyes on the future needs to be able to manage and take advantage of debit and credit to grow their business.

A reputable lender can help advise you on what loan opportunities you can and should pursue. Loan rates and requirements are not just a matter of how long you’ve been running a business or how good your credit history is. This can also depend on your company’s relationships with any given vendor or lender. Now you have your answer for “How do commercial loans work”.

Even when you don’t need a loan, a line of credit or short-term loan can help you build critical financial ties for the future – and protect your business against the unforeseen.