Types of Commercial Loans

What is a Commercial Loan?

A commercial loan is a financing option specifically designed for businesses to fund operations, purchase equipment, or invest in real estate. Unlike personal loans, commercial loans are structured to address the unique needs of businesses, providing the necessary capital for growth, expansion, and managing day-to-day operational expenses.

Commercial loans typically involve larger sums of money and stricter lending criteria, including creditworthiness, business revenue, and collateral. They are often used for purchasing commercial real estate, acquiring inventory, financing equipment, or covering operational costs. Businesses rely on these loans to manage cash flow, invest in growth opportunities, or make essential improvements. 

Understanding the Different Types of Loans

There are several types of commercial loans, each serving different needs. Common types include term loans, lines of credit, and commercial real estate loans. Term loans provide a lump sum for a fixed period with lower interest rates and fixed repayment schedules, making them ideal for long-term investments. Lines of credit offer flexible access to funds, perfect for managing cash flow fluctuations. Commercial real estate loans are tailored for purchasing or refinancing property with extended repayment terms.

Choosing the right type of commercial loan involves evaluating your financial goals and current situation. Consider factors such as the amount of funding required, repayment capacity, and the loan’s purpose.

1. Commercial Real Estate Loans

Commercial real estate loans are vital for businesses looking to acquire, refinance, or develop properties. Types of commercial real estate loans include purchase loans for acquiring new properties, refinance loans to improve cash flow by consolidating existing debts, and construction loans for new building projects. Each type serves a unique purpose, allowing businesses to choose the option that fits their strategic goals.

To qualify for a commercial real estate loan, businesses must meet specific criteria such as solid credit history, sufficient cash flow, and a detailed business plan. Required documentation includes financial statements, tax returns, property appraisals, and information about the intended use of the property. 

Commercial real estate loans significantly enhance your business's growth potential. Whether expanding operations, increasing profitability through strategic refinancing, or investing in new construction, these loans provide the necessary capital to achieve your goals. TowneBank is committed to supporting your journey with tailored financing solutions that align with your vision, helping you transform opportunities into successful outcomes.

2. Business Line of Credit

A business line of credit is a flexible financing option that provides access to a predetermined amount of funds. Unlike traditional loans, which offer a lump sum with fixed repayments, a line of credit allows borrowers to draw money as needed, up to the approved limit. This flexibility is ideal for managing fluctuating cash flow, seasonal expenses, or unexpected costs.

When deciding between a line of credit and a traditional loan, consider your business’s financial needs. Traditional loans are suited for larger, one-time expenses like purchasing equipment or funding major projects. Whereas, a line of credit is more appropriate for ongoing operational costs or quick cash flow solutions, allowing you to access funds without the burden of fixed repayments.

One of the key benefits of a line of credit is its ability to enhance cash flow management. By providing immediate access to funds, it ensures your business can respond swiftly to opportunities or challenges, whether purchasing inventory at a discount or covering unexpected repairs. This financial agility helps maintain operations and can improve your business’s overall financial health. 

3. Equipment Financing

Equipment financing offers businesses several options, including loans and leases tailored to specific needs. Equipment loans allow you to borrow a set amount to purchase machinery, with the equipment serving as collateral. Alternatively, equipment leasing enables you to use the equipment without significant upfront costs, paying a monthly fee for a specified term. Both options can be structured as fixed or variable rate agreements, offering flexibility based on your financial strategy.

Financing equipment presents numerous advantages, such as preserving cash flow and providing tax benefits. Interest payments on loans may be tax-deductible, and leasing can help you avoid depreciation issues associated with ownership. Equipment financing also allows you to upgrade to the latest technology without significant capital investment, ensuring your business remains competitive in a fast-evolving market.

Lenders consider several factors when evaluating equipment loan applications, including your business's credit score, the age and condition of the equipment, and your business’s financial statements. 

Commercial Loan Qualification Criteria

Commercial loans come in various types, including short-term working capital, lines of credit, term loans, and commercial real estate loans. Lenders range from commercial banks and mutual companies to private lending institutions and hard money lenders. These lenders typically have varying standards for loan criteria and borrower evaluation.

The Three C's of Commercial Lending

Nearly all lenders will assess these factors for income-producing commercial real estate properties. Borrowers are usually required to assign leases/rents of the collateralized property, providing additional security to the lender. A commercial appraisal is a significant part of the underwriting process, used to derive the sales comparison, income approach, replacement cost, and overall real estate value. Each lender has different credit requirements, with an industry-standard minimum for personal credit requirements.

The list of items needed to qualify for a commercial loan is extensive and may require ongoing documentation throughout the loan's life. Lenders may ask for annual or quarterly income statements, tax returns, or balance sheets. Income tax returns and 3 to 5 years of financial statements are typically required, along with corporate documents, asset statements, leases, and the business owner’s personal financial record.

Commercial loans carry a higher perceived risk for lenders than residential loans, as several government entities do not back them. Commercial mortgage underwriters conduct thorough due diligence to ensure the borrower is fully qualified. Lenders weigh the business’s debt against its cash flow, with most banks expecting a minimum of 20 percent higher net income than debt carried.

The debt service coverage ratio (DSCR) is a critical factor in commercial real estate lending, calculated by comparing net cash flow to mortgage debt service (principal and interest payments). This ratio helps determine how much a borrower can afford for a monthly commercial loan payment, typically ranging from 1.1 to 1.4. The DSCR and loan-to-value (LTV) ratio are important considerations for lenders when issuing a commercial mortgage.

Commercial rentals have unique lending nuances, allowing borrowers to assign an interest in leases or rents from the building. Lenders may include contingencies to take rents and profits if the borrower defaults on the mortgage. A commercial real estate loan also considers the LTV ratio, which helps determine the interest rate.

If a borrower does not qualify through traditional lending institutions, private lenders may offer alternatives. Hard money loans, typically used as temporary financing, carry higher interest rates, but provide an option when traditional loans are not feasible. Commercial lending often requires higher down payments and more stringent guidelines.

Let's Work Together 

No matter your financial goals, you have a partner at TowneBank that is willing to help you figure out the specifics. At Towne, we're not just a bank, we're also your neighbor. Reach out to see how we can help you grow in your industry and the community you serve.