The Most Important Commercial Loan Types for Small Business Owners
March 28, 2022 | Last Updated on: July 27, 2022
March 28, 2022 | Last Updated on: July 27, 2022
This article will show you:
As a small business owner, you probably donâ€™t want to remain in startup mode forever. At some point, you will want to take your business to the next level. But to do so, you need the financial resources that will help you realize the visions you have for your company.
Itâ€™s vital to choose the right type of loan for your businessâ€™s needs, whether that need is to expand your business, inventory or equipment financing, commercial building financing, to fill in seasonal gaps in revenue, or get help when your customers are slow to pay, and you have unpaid invoices.
The truth is, there isnâ€™t a one-size-fits-all commercial loan that is best for every small business context. At each stage of your business, one type of loan will likely prove more useful than another.
While there are many types of business loans that serve varying needs, four work best for small businesses. These include business term loans, working capital loans, commercial real estate loans, and business lines of credit. Hereâ€™s a closer look at each one.
A business term loan is one of the most frequently used commercial loans. This is because it serves a wide variety of small business needs and offers many benefits for you as a business owner.
It can be used to grow your business, whether it be through opening another business location (real estate or a franchise), buying new equipment, or increasing your inventory or other offerings for your customers. Term loans can sometimes be used to consolidate or refinance business debt or hire new workers.
The great thing about a term loan is that you can pursue new business opportunities without impacting your businessâ€™s operational cash flow or working capital.
The lender gives you the full borrowed amount of money upfront, and you make regular monthly payments until the loan is paid off.
Term loans typically have lower interest rates than other types of business loans. You can also deduct the interest you pay on a term loan from your businessâ€™s taxes.
Commercial term loans usually have a repayment period of one to 25 years, depending on the lending criteria and the purpose of the loan money. For instance, if the term loan is used for equipment, a lender will usually offer a repayment schedule that matches the life expectancy of the equipment. But if youâ€™re purchasing commercial property, some lenders will allow you the maximum time to pay back your loan.
Small business owners can usually borrow from around $25,000 to $500,000, depending on their creditworthiness.
Business term loans are usually best for businesses that have been operating for at least 18 months and have more than $250,000 in annual revenue.
Many banks and financial institutions can take months just to render a decision for your loan. This is because they have stringent lending requirements and want borrowers with a nearly perfect credit history.
Thankfully, there are commercial loan options that are good for business owners who need fast funding or donâ€™t have the best credit scores.
For instance, Biz2Credit only requires a 660 credit score and usually approves a borrower within 24 hours.
Before diving into how a working capital loan works, letâ€™s first look at what working capital is.
Working capital is the money your small business uses each day to pay for operational expenses, such as payroll, supplies, inventory, utilities, your businessâ€™s rent or mortgage, etc. In other words, itâ€™s the capital your business needs to operate.
A working capital loan can be used to boost your businessâ€™s level of working capital. It can also be used for many of the same purposes as a term loan, whether for purchasing inventory or equipment, hiring new staff, or growing your business.
Working capital loans consist of various types of business financing, including short-term loans, merchant cash advances, and invoice factoring.
The primary advantage of a working capital loan is that it is relatively easy to qualify for, and the repayment terms are sometimes more flexible than with a standard term loan.
A working capital loan will help you meet a shorter-term business need, and you often donâ€™t even need collateral or perfect credit to qualify for the loan.
Working capital loans typically come at higher interest rates, especially if your loan is unsecured and doesnâ€™t have collateral. This means that repayment of the loan will cost you more overall.
You also usually have a shorter time to pay back a working capital loan, so again it should serve a short-term business need or disruption in your cash flow, and itâ€™s not suitable for long-term needs.
A commercial real estate loan is a secured loan that can help your small business seize new opportunities.
Funding from a real estate loan can provide financing to:
Commercial real estate loans use your businessâ€™s existing real estate property or property you plan to purchase as collateral.
Purchasing commercial real estate provides a real investment opportunity for you. Once your loan is paid off, you retain ownership of the property.
And if your alternative is leasing, remember that leasing doesnâ€™t allow you to build equity in the real estate you run your business out of. Once you make lease payments, that money is essentially gone.
Commercial mortgage loans also usually come with lower interest rates than unsecured loans.
Depending on the lender, the credit requirements might be lower than with some loans because the loan uses collateral. For instance, Biz2Credit requires a credit score of 660 or higher, whereas some lenders prefer 700 or more.
You can also make significant capital gains when you purchase real estate, offering you the benefits of long-term investments because real estate value tends to go up over time.
And, if you have extra space available in your commercial building or property, you can potentially rent it out to generate more income, which can help you make your commercial real estate loan payments more manageable.
Most lenders will require that youâ€™re in business for at least 18 months or more to qualify for a commercial real estate loan.
Commercial mortgage financing also has higher fees than other small business loans, including origination fees and closing costs.
Depending on the lender, you may be required to put down a hefty down payment for a real estate loan.
Many lenders will also require that your business is already bringing in steady revenue, typically around $250,000 or more annually.
Commercial real estate ownership also comes with more responsibilities. For instance, youâ€™ll be responsible for the upkeep and maintenance of the premises. When you lease commercial real estate, it falls back on the landlord to deal with those things.
And while commercial estate does tend to go up in value, thereâ€™s always the chance it could go down. This could affect your borrowing power later on or prevent you from recovering your full investment if you decide to sell at some point.
Business lines of credit can help provide your business with quick cash when you have a short-term gap in your businessâ€™s cash flow.
You can use a business line of credit to pay for unexpected business expenses, operating expenses, or other needs.
Rather than a lump-sum disbursement you typically have with a term loan, the lender approves you for a set amount up to a predetermined limit.
You can then access the credit as needed, up to the limit provided.
The biggest advantage is that you only pay interest on the amount of financing you access from the line of credit.
Once approved, a line of credit is accessible immediately, whenever you need it. The line of credit allows you greater freedom in managing your businessâ€™s cash flow, particularly during downturns in your business. It also provides a way for you to seize a business opportunity that might be time-sensitive.
A business line of credit usually has lower interest than a credit card, particularly when you show that you have strong business revenue and your credit score is higher.
And if you donâ€™t have the best credit score, a business line of credit is a great way to improve it. You might have to pay a higher interest rate than a business owner with a flawless credit record, but it will still be lower than some other business loans.
A business line of credit usually offers you a lower financing amount than other financing, such as a term loan. So it may not be helpful if you need a larger cash infusion into your business.
And, as with credit cards, there is always the potential to mismanage the funds, though if you are a savvy business person, itâ€™s unlikely this will happen to you. Still, itâ€™s best to remain aware and think every expenditure through before utilizing your line of credit.
The three primary ways of getting financing for your small business are through a traditional lender like a bank or credit union, the SBA, or an online lender or lending marketplace.
Recently, it has become more challenging to qualify for a commercial loan through a traditional financial institution. Their credit requirements have become more rigorous and the approval and application process is lengthy.
Traditional lenders are exhaustive in their efforts to scrutinize your tax returns, financial statements, personal credit scores, business credit history, accounts receivable and payable, and more.
In the end, many small business owners are turned down for their commercial loans.
The U.S. Small Business Administration (SBA) offers several commercial loan programs for small business owners, including term loans, commercial real estate loans, SBA microloans, lines of credit, loans for veterans, and more.
The premise behind an SBA loan is they offer a guarantee to a third-party lender such as a bank or online loan provider that the government will back up the loan if the borrower defaults. The SBA guarantees 75% of the loan if itâ€™s more than $150,000 and 85% of loans that are $150,000 or less.
The SBA 7 loan is one of the more popular SBA loan programs, and it makes up to $5 million available to small business owners. This type of financing can be used to:
The SBAâ€™s loan eligibility process is as stringent as traditional banks, if not more so. As with any commercial financing, youâ€™ll need to have a sound business plan and prove your creditworthiness.
Moreover, the SBA will take a deep dive into your government debt obligations, such as student loans and taxes. All government debts have to be up to date before the SBA will consider a business loan.
If you can make it through the rigorous qualification and approval process, the SBA offers 5 to 10 years to pay back a 7(a) loan, sometimes more if itâ€™s a real estate loan (up to 25 years).
Online lenders and marketplaces have quickly become one of the best financing options for a commercial loan.
Todayâ€™s business landscape is constantly evolving and highly competitive. This means that when a small business owner has a business opportunity or needs a cash infusion for their business, time is of the essence. Most business owners donâ€™t have months to wait and see if their small business loan application will receive approval.
This has ushered in a new and better way to get financing for your small business. An online lender like Biz2Credit can have fast funding from your commercial loan in your bank account, often within a few days rather than months.
The most important commercial loan is one that you can receive when your business needs it. Various factors will influence which type of business loan is best for your company. Chances are, at different points in operating your business, you will benefit from multiple types of commercial loans.
The important thing is to grow your business and seize opportunities that facilitate that growth. Biz2Credit is a commercial loan specialist that has successfully facilitated hundreds of loans for small business owners and entrepreneurs. We can do the same for you.