What is a Commercial Loan?

Introduction

Every business need funds for expansion purposes like opening a new facility, or buying high-end machineries, or anything for that matter. The favourable yet a legit source to get funds is from a bank or a financial institution.

Fig 1: Commercial Loan

This kind of credit lending is referred to as a commercial loan. Also known as business loan, this debt facility is granted to businesses to meet their specific financing needs and facilitate their day-to-day activities. Let’s take a look at their types, pros and cons, and other particulars in here.

Explained: Commercial Loan

A commercial loan is business loan taken from a financial institution to finance their business needs like purchasing raw materials, paying salaries, building a new factory, etc. Companies utilize these funds for operational purposes to keep the business functional. Unlike personal loans, the commercial loans endure through a lot of documentation.

These loans can either be secured or unsecured depending on the purpose and the amount you need. While all the while, most of the commercial loans ask for collateral security as a deposit before claiming the authority over the funds. The collateral can be like a property, plant, or anything that equalizes or values beyond the loan value.

Upon default or bankruptcy, the lender gets the say over the company’s collateral assets. Meaning, if the borrower fails to repay the loan, the lender can seize the collateral and sell them in the market and recover the debt. Commercial loans can be short-term or long-term, as that pivots on what grounds they are taking the funds. The loan disbursement process is a bit lengthy due to the prolonged paper work involved.

Kinds of Commercial Loans

There are several aspects a lending institution looks into before giving the green signal to the borrower. Some of them includes loan-to-value ratio, financing methods, interest rates, amortization period, etc. Since businesses require loans for multiple uses, they are classified into different types accordingly. Below is the list of kinds of commercial loans along with a brief explanation.

• Working Capital Loans − The main aim of this type of loan is to finance the daily operations of the business. This asset-based lending is unsecured in nature and doesn’t involve the need for collateral as well. Working capital loans purpose is to fulfil the business needs during their functional hours like paying bills, buying a new equipment, and among others. Here, only creditworthiness of the borrower is taken into consideration instead of your collaterals. For such type of loans, the risk is pretty high, so is the interest rate. Businesses should use this loan only for working capital purpose and nothing else. Apart from that, they have to pay the loan amount within a year.

• Term Loans − The lender offers the loan amount in lump sum to the borrower in term loans. Businesses use these funds to take possession of fixed assets like machinery, buildings, furniture, and others. Lenders sanction this loan only to those borrowers whose financial statements appear to look good. These loans are to be repaid irrespective of the financial health of the company. The loan value decreases as the borrower keeps paying them periodically. The repayment terms between the lender and borrower are predetermined in advance.

• Line of Credit − Technically, the line of credit is not considered a loan but more like an advance. It’s more like a credit card with a predefined limit set by the lender. Unlike a personal loan, businesses can use line of credit for anything they need.

Fig 2: Types of Commercial Loans - Line of Credit

There are no terms and conditions for this loan, making it as the most flexible option by many businesses. Best of all, there’s no fixed time frame for repayment, as the balances keep changing frequently. The borrower can borrow only to the extent of the agreed limit. Interest is paid to the lender only on withdrawal value.

• Acquisition Loans − This asset-based lending is entirely for acquiring new entities or businesses. This loan should be used only for a specific purpose. The tenure of this loan is less compared to other types of commercial loans. Some of the types of acquisition loans includes SBA loans, equipment financing, business expansion loans, etc. The LTV and amortization period of this loan is wee than other loans.

Pros of Commercial Loan

Knowing the types of commercial loans available, choosing the one that fits your business needs can be an easy-peasy task. But why should one opt for a commercial loan? Check out the pros listed below.

• Repayment Tenure − Paying loans is not an easy process unless your finances are stable with good cash flows coming in at regular intervals. Commercial loans offer the repayment tenure of 3 to 5 years depending on the loan amount and purpose.

• Boosts Economic Growth − Commercial loans are implicitly or explicitly linked to the economic growth of the country. As banks lend such loans to the businesses, they are contributing to the company’s development in one way or the other. This results in generating sound profits and opens the door for new opportunities.

• Access to Higher Loan Amount − Irrespective of the credit limit, commercial loans are available at lesser interest rates as opposed to other types of loans. So, if businesses need quick access to higher loan amount, they can go for commercial loans instead of venture capitalists or other modes. This facility is a one-stop solution for all your business hitches.

• No Collateral Required − These days, banks ask for collateral for almost all sorts of loans. However, that’s not the case for commercial loans, as some of them are unsecured. As it suggests that the business doesn’t need to furnish any asset as collateral. Commercial loans with no-collateral includes SBA loans, equipment financing, unsecured line of credit, term loans, and others.

Cons of Commercial Loan

Just like every coin has two sides, so is for commercial loans as well. So, here’s the draft of some of the cons associated with this mode of lending.

• Furnishing Past Financial Statements − Businesses applying for commercial loans should have a sound financial record. On failing so can lead to immediate rejection of your loan application request. So, it’s important to check your past financial statements prior to approaching the lender for a commercial loan.

• Not The Right Fit for Unsecured Loan − Sometimes, our financial records won’t be sufficient to meet the unsecured loan requirements. When it comes to secured loans, you have to furnish the necessary assets as collateral with the lender. Upon default, the collateral assets will be confiscated and sold to reclaim the due.

• Oblivious of Loan Requirements − Companies have to be transparent about the purpose of the loan. Being oblivious of the loan requirements ends the business in a rabbit hole, leaving the company in a coil of interest payments.

Conclusion

Businesses require extra working capital to meet other needs such as building a new plant, investing in other projects, expanding the business internally, refurbishing the machinery, etc. Banks offer commercial loans for such entities to boost their growth, which subsequently, elevates the economy at large. One doesn’t need any collateral to avail commercial loans, that too having access to considerable amounts.

FAQs

Q1)How commercial loans play a major role in economic development?

Ans)Big companies are always on a quest for funds for expansion and growing. Banks give their helping hand in the form of offering commercial loans to these companies. As these firms develop, they are not only providing employment aid but also contributing a major share to the GDP growth and overall economic development.