Commercial Loan

Key Features of a Commercial Loan

• A commercial loan is appropriate for a specific business purpose or expenditure
• The structure of credit for commercial loans is much more complicated than personal loans.
• Three of the most common types of commercial loans are commercial mortgages, lines of credit, and term loans.
• Commercial loans are mostly secured meaning that they are always backed by collateral.

Structure of Commercial Loans

Most commercial loans given by traditional financial institutions are backed by collateral. Most lenders don’t extend credit continuously or without any specific reason for the funds lent. This is referred to as credit structure or loan structure by bankers. The following are examples of questions that a lender must ask themselves when structuring a commercial loan.

• Will the financing be revolving/operating credit or decreasing term debt with scheduled repayment intervals?
• Will any assets serve as collateral for the exposure?
• What is the maximum loan-to-value we are willing to offer against the asset being funded?
• What is a suitable amortization period based on the purpose of the commercial loan?
• What should the interest rate be to compensate for the borrower’s projected default risk?

Commercial loan structure is usually guided by predetermined credit policies.

Types of Commercial Loans

Some of the most common types of credit available to support businesses are:

• Lines of Credit: A Line of Credit is used to support the working capital cycle for firms that sell on credit terms. The repayment schedule is not set and it will ideally revolve up and down as balances change in the company’s working capital accounts.
• Term Loan: A term loan is a loan provided for business purposes and it has to be paid back within a specified time frame. It comes with a fixed interest rate, set maturity date, and monthly or quarterly repayment schedule. Term loans can be both secured (backed by a collateral) and unsecured. Secured term loans have a lower interest rate than unsecured loans. Depending on the repayment period, this loan type is classified as follows:
• Short-term loan: The repayment period is less than 1 year.
• Medium-term loan: The repayment period is between 1 to 3 years.
• Long-term loan: The repayment period is more than 3 years.
• Capital Leases: Capital leases are similar to term loans. They are used to fund capital assets like equipment. The main difference between a capital lease and a term loan is that the equipment finance firm funding the lease keeps the legal title of the physical asset (As opposed to registering a lien over it).
• Commercial Mortgages: Commercial mortgages are used to fund or refinance commercial estate. The property can be an investment property that produces investment or it can be an owner occupied property. Depending on this, the analysis and the underwriting techniques differ.
• Acquisition Loans: Acquisition loans are particularly used to acquire another business or strategic assets such as equipment. These loans are availed by the business, since they cannot purchase these assets with the company’s normal cash flow. These loans relieve business owners from the pressure of raising capital for purchases. Using an acquisition loan, your company can make big strategic purchases by paying as little as 15% down and then paying off the outstanding amount over a period of time.

The Commercial Loan Process

The 5 steps of the commercial loan process are:

• Loan origination: The relationship team goes out and looks for prospects or for potential borrowing clients.
• Understanding of the client and credit structure: Here is where the team of lenders (including the relationship manager and the credit analyst) seek to understand the health of the business, its specific borrowing needs, and how the deal might be structured and priced.
• Analysis and Underwriting: Analysis and underwriting are done once the team gets the client’s commitment to progress forward on a formal credit application. At this point, the bank’s credit committee must provide the final approval of the proposed credit structure.
• Documentation and improving security: Post the approval of the deal and execution of the agreement, any charges against the business and its assets are registered correctly by the lender’s counsel. And finally, the loan is provided to the borrower.

Pros of Commercial Loans

Commercial loans provide multiple key advantages to business owners.

• Offer low-interest rates: Commercial loans offer lowest interest rates as compared to all other business loans. This enables business owners to get easy access to funds while maintaining lower overhead costs.
• Long-Term Loans: The loans have longer and flexible repayment periods ranging between 3 to 10 years. You can thus pay the money back at a comfortable pace and focus on working towards increasing the business profits.
• Decreased potential for Default: The potential for default is low due to extended repayment periods and lower interest rates.
• Huge loan amounts: Commercial loans are usually huge loan amounts and you can cover entire startup costs using a single commercial loan.
• No Collateral: Commercial loans do not require any collateral since they are unsecured loans.
• Cost-effective loan option for business owners: With lower interest rates and flexible repayment periods, commercial loans offer the most cost-effective loan option for business owners.
• Help You retain total ownership of the business: Venture capital investments require you to sign up a fraction of your company to the investor. Whereas commercial bank loans enable you to retain total ownership over the business.

Cons of Commercial Loans

Low interest rates and adaptable payment plans make commercial loans an extremely viable option. But, they have their own disadvantages

• You need excellent business credit to qualify for a commercial loan. So, first-time business owners will probably not be eligible and have to build their credit score before applying.
• The application process is comprehensive, often requiring a detailed financial report of the business, accurate evaluation of projected revenues, and detailed information about all the pertinent risks. The proposal should be highly persuasive and must ensure bankers that there is a relatively low risk of business failure.
• Provide your personal financial history: You need a very good financial history to be eligible for a commercial loan. You should provide your complete financial history including your credit score, annual income, and unpaid debts. Even small problems with your financial history can make you ineligible for the loan.
• Commercial loans provide less personal autonomy: When the commercial loan amount is higher, you have to give a detailed explanation about the end usage purpose.
• Secure the loan with your home or car as collateral: If you do not qualify for an unsecured loan, you may have to secure your loan with your home or car as collateral. If you default on a secured loan, the bank retains the right to seize your property.

Conclusion

Commercial loans are the most viable option since they come with low-interest rates and extended repayment periods. However, to qualify for a commercial loan, you need an impeccable business and financial history. Secured loans are there for those who do not qualify for an unsecured loan. But, they are loaded with greater financial risk.