Commercial Loan Definition, Types & Calculation
Growing and expanding a business is an exciting time. There is a lot to look forward to and several opportunities available to pursue. Yet, sometimes business growth can require overcoming some challenges not necessarily within your control.
For example, what if you want to fund major capital expenditures or cover significant operational costs? Do you have the profitability or revenue to be able to cover these costs on your own? This is where a commercial loan can come into play and there can be several benefits.
Keep reading to learn everything you need to know about commercial loans, including the various types and the calculations used!
Table of Contents
- A commercial loan happens between a bank or financial institution and a business. It’s used to help fund various capital expenditures or operating costs.
- Providing collateral is a common requirement when taking out a commercial loan. These can often include things like property or equipment.
- While most commercial loans cover short-term periods, there’s often a possibility to renew or extend them.
- Most commercial loans require the business to provide their financial statements to help prove they would be able to pay back the loan.
What Is a Commercial Loan?
A commercial loan is a type of funding arrangement that a business can have with a financial institution, like a bank. They’re typically meant as debt-based funding and are helpful if your business needs a little extra financial assistance. For example, if you wanted to cover certain operational costs or help fund some major capital expenditures then a commercial loan can help.
Small businesses often face financial constraints, like expensive upfront costs or other hurdles to overcome. This makes it difficult to gain access to and be eligible for financing, which could come through things like bond and equity markets.
Where many individual consumers have easier access to these types of funding, small businesses often need to rely on other lending products. These can include things like term loans, unsecured loans, or even lines of credit.
How Does a Commercial Loan Work?
The main concept of a commercial loan is to provide assistance with short-term funding. Several types of businesses can have access to this. And they’re usually used to help with things like operational costs or purchasing equipment. Basically, a commercial loan assists businesses with their operating processes.
But that’s not all a commercial loan can get used for. Sometimes a business can have difficulty, especially early on, with meeting operational needs. So a commercial loan can also assist with purchasing necessary supplies or funding payroll requirements.
When you approach a bank to take out a commercial loan, they’re often going to require you to provide collateral. This is to help ensure that if your business defaults or files for bankruptcy you will still be able to repay the loan amount. Some of the most common forms of collateral can include property, plant, or equipment.
Are There Any Special Considerations with a Commercial Loan?
As is the case with an individual consumer, businesses are still required to have certain creditworthiness. This is one of the most important factors that a bank will take into consideration when offering a commercial loan.
When this happens, the bank will typically ask you to provide some different pieces of documentation, such as balance sheets. This information helps prove that your business has consistent and favorable cash flow. Banks want to know and have this information so they can ensure you’re able to follow the terms and repay the loan.
If you’re approved for a commercial loan, the rate of interest you’re going to have to pay will typically align with the prime lending rate. After the loan has been issued, you will also likely need to provide the bank with regular financial statements. This is done throughout the loan duration.
What Are the Types of Commercial Loans?
The type of commercial loan you decide to pursue for your business will often depend on what you need it for. The good news is that there are several different types of commercial loans you can explore. So, if you need to purchase new office space or fund the next step in your business strategy, there will likely be one that suits your needs.
Here are some of the most common types of commercial loans:
- Equipment financing
- A business line of credit
- Commercial real estate loan
- Commercial auto loan
- Small business administration (SBA) loan
- Commercial construction loan
- Inventory financing
- Bridge loans
The main thing to consider is what you’re going to need your loan for. From here, you can ensure that the commercial loan you choose will cater to exactly what you need.
Calculation of Commercial Loans
There are a few different factors that can affect your commercial loan calculation. For example, it will depend on the total loan amount, the interest rate, and the length of term. Here’s a breakdown of how these specific details might get calculated.
Let’s say that you wanted to take out a commercial loan of $100,000 with a term of 5 years. The bank has let you know that you will be paying an interest rate of 5%.
Your first monthly payment would be $1,887.13. Out of that amount, $1,470.46 would go towards the principal, with the other $416.67 going towards interest.
It’s important to keep in mind that as each month goes on, the principal payment will increase and the interest amount will decrease. Once the loan is entirely paid off, you would have a total payback amount of $113,227.34.
As well, interest rates can fluctuate depending on the specific type of commercial loan you’re looking to take out.
If you wanted to calculate a commercial loan yourself, you can use the following formula:
A commercial loan can be a great way to provide some financial relief to your small business. It’s not always possible to fund your own expansion or purchases. As debt-based funding, commercial loans are very helpful with this financial assistance.
If you want to move forward with certain operational costs or fund new capital expenditures, a commercial loan can help. There are also a few different types, such as equipment financing, bridge loans, inventory financing, and others. The most important thing to keep in mind is what you actually need the loan for.
It’s also often a requirement to provide collateral to the bank to ensure repayment can be made. As well, they will also usually require you to provide financial statements to make sure your business has a steady cash flow.
FAQs About Commercial Loans
How Long is a Commercial Loan?
This will depend on a few different factors. Yet, most commercial loans can range from five years or fewer to up to 20 years.
Is it Hard to Get Approved for a Commercial Loan?
Whether or not your business is approved for a commercial loan depends on a few things. The bank will look into credit scores as well as if your business has solid cash flow. So if both of these are on the lower end, it could be difficult to get approval.
What Is a Non-Commercial Loan?
Simply put, a non-commercial loan is when you borrow other amounts of money from a financial institution that isn’t a commercial loan.
What Is a Bridge Lender?
This is a type of temporary financing option for a business. It helps to cover certain costs until the business can get other, more permanent financing.
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