How Do Commercial Loans Work?

How Do Commercial Loans Work?

How Do Commercial Loans Work?

Small business loans, specifically commercial loans, were designed to provide assistance to businesses who need a working capital boost, whether it be to address everyday costs or to begin the next stage in their business journey. 

If you’re looking for info on commercial real estate loans, feel free to skip down to the section on real estate-specific loans.

How do commercial loans work?

There are many types of business financing options under the commercial lending umbrella, though most will have set terms, fixed monthly payments, and rates based creditworthiness. However, there are different types of commercial loans as well as commercial lenders. For example, some commercial loans will require the borrower to put up certain assets as collateral while others will require a down payment, while options such as unsecured loans may not require such steps.

As such, everything from the application process to the repayment can vary for small business owners. The same is true for eligibility requirements.

What types of commercial loans are there?

There are various types of commercial loans available to businesses, and often the right one comes down to intended use. There are, for instance, several commercial financing options that can be used for a number of purposes. Others, however, are specifically designed to manage real estate needs.

Multi-purpose commercial loans

SBA Loans

Small Business Administration (SBA) loans are backed by the SBA and approved and originated by lenders. There are numerous loan programs available through the SBA, but the SBA 7(a) loan program and the 504/CDC loan program are the most popular.

To be eligible for these loans you must be considered a small, for-profit business that operates within the U.S. In addition business, according to the SBA guidelines, that operates as a for-profit business within the United States.  

This loan is considered the most popular SBA loan and can be used for a variety of working capital needs. This includes purchasing equipment, managing operational expenses, purchasing land, and consolidating debt.

SBA loans are typically available up to $5 million, and though there is no limit, loans under $30,000 are not common. Working capital, inventory, or equipment loans carry terms of 10 years while real estate loans and other SBA loans may carry terms as long as 25 years.

Rates are based on a number of factors including the current prime rate, loan amount, loan term, and your credit. Currently, borrowers can expect rates between 7.25% and 9.75%. However, the SBA limits low rates as follows:

SBA Loan Rates

Loan Amount Loans less than 7 years Loans 7 years or longer
$0 – $25,000 Prime + 4.25% Prime +4.75%
$25,001 – $50,000 Prime + 3.25% Prime + 3.75%
Over $50,000 Prime + 2.25% Prime + 2.75%


  • SBA 504/CDC loans

This particular type of small business loan is provided by Certified Development Companies (CDCs), which are non-profit companies that promote economic growth within a specific area.

Approved applicants can expect funding amounts up to $5 – $5.5 million dollars with terms typically ranging from 10 to 20 years.  

Unlike SBA 7(a) loans, which offer a bit more flexibility, 504 loan proceeds must be used for one of the following:

  • Purchase an existing building
  • Purchase land or improving lands (e.g., parking lots, grading, landscaping etc.)
  • Construct a new facility
  • Modernize, renovate, convert, or existing facility
  • Purchase long-term machinery
  • Refinance expansion or renovation debt.

Business line of credit

While loans provide access to a single lump-sum of cash, lines of credit offer access to revolving debt, similar to a credit card. For instance, if approved for $25,000, you’ll be able to access up to $25,000 for the duration of the draw period, and you’ll only be charged interest on what you use.

You can use and repay the funds as often as you wish during the draw period, but once you enter repayment, you’ll no longer have access to the line of credit.  

This type of business lending situation is often ideal for businesses who need to account for seasonal revenue disruptions, purchase inventory or supplies, or account for other expected or unexpected gaps in cash flow.

Lines of credit can be obtained from traditional lenders like banks alternative lenders like online finance companies, and even some private lenders. As such, rates, terms, and amounts can vary. However, borrowers can typically access between $5,000 and $250,000 with rates between 6% and 20%.

There are, however, lenders that have rates well about the 20% mark.

Business credit cards

When used responsibly, business credit cards can be valuable financial tools for small business owners. They can make it easier to manage and track spending, provide additional working capital, and in some cases, even help you earn rewards.

Credit cards have few usage exceptions — you won’t have to limit spending to materials, labor, etc.– which make them flexible enough to handle many spending needs. However, if you’re considering a credit card to manage expenses or for a cash advance, there are a few things to keep in mind.In some cases, credit card interest rates can reach about 20%, particularly if you have average or below average credit. As such, they may not always be ideal for carrying large balances.

When possible, choose a credit card that offers low interest — one that offers a 0% introductory APR offer is ideal. Further, you may also want to consider credit cards that offer rewards programs, as these can help you earn points, cash back, or miles when making everyday business purchases.

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Vendor credit

Though this may not be a commercial loan in the typical sense, it can still be extremely valuable to your business.

Vendor credit allows you to purchase goods or services from a specific vendor without cash up front. Instead, you can pay later. Though many vendors offer net-30 accounts, meaning you must pay up in thirty days, there are also vendors that offer net-60 and net-90 days.

This type of arrangement frees up working capital and give you time to turn goods or services into tangible profits before you need to begin to repay the loan. It’s also important to note that vendor credit can also help you build business credit. And, better business credit will make it easier to secure affordable financing in the future.

If you’re considering a vendor credit as a means to improve your business credit score, be sure to work with vendors who report to the major commercial credit agencies such as Dun & Bradstreet, Experian, and Equifax.  

Real estate-specific commercial loans

Long-term fixed interest rate “mortgage” loans

Much like its consumer counterpart, this type of commercial loan allows you to purchase property.  A business mortgage or commercial real estate loan, however, can only be used to purchase income-earning property This includes things like retail shops, office space, hotels, etc.    

Long-term fixed interest rate mortgage loans are typically available for 5 to 20 years, with rates between 3% and 12%. In addition, commercial mortgages also typically come with a number of upfront costs including origination fees, appraisal fees, survey fees, etc.

In addition to fees, most lenders will also require borrowers to put down a 20% to 30% deposit based on the total amount of the loan.  

Hard money

Hard money loans are short-term loans used to purchase real estate, frequently with the goal if investment. For that reason, this type of loan is most often leveraged by individuals hoping to invest in and flip a property.

Unlike mortgages, these loans are not originated by traditional lenders; instead, funds typically come from private investors. Another difference worth noting is that eligibility is typically based on the property value, not the applicant’s creditworthiness. The assumption is that if the  borrower can’t make payments, the lender will use the property as collateral, selling it for a profit.

These loans are notoriously more expensive than other options, with a variable rate ranging from 7% to 15%, on average. As such, they should be used with caution.

Why use one at all? Despite high-interest rates, they are considered to be a much faster pathway to funding when compared to other real estate loans. And, since they are based on the value of the property and not an applicant’s credit history, they may be easier to obtain in some cases.

Mortgage or real estate bridge loan

Fundamentally, a business bridge loan can be any short-term loan (months to a few years) that provides quick access to funds and is used to “bridge” a gap in expenses. As such, this term is frequently used to refer to a number of lending situations.

In this case, a real estate bridge loan provides the capital necessary to make a commercial real estate purchase without enduring the long-process often associated with long-term business financing, like mortgages. These may come in handy when attempting to take advantage of a real estate opportunities, moving your business, or performing rehabilitation that will result in increased value.

Ideally, bridge loans are repaid quickly when pending capital becomes available. However, in some cases, borrowers will need to refinance their bridge loan through another loan, be it traditional loans, SBA loans, or another, more affordable loan.

Construction Loans

As the name indicates, this type of loan is used to fund new construction or repairs and renovations to existing constructions. Funds can be used to cover the costs of land or property, materials, and labor.

Unlike other types of commercial loans that provide borrowers with a lump sum of money, a commercial loan is released in increments. Borrowers must work according to a draw schedule that specifies specific milestones upon which more funds will become available.

Generally, interest rates range from 4% to 12% but vary based on prime rates, type of lender, amount of loan, and the borrower’s creditworthiness. In addition to interest, borrowers who qualify can also expect a variety of fees (like project review or fund control fees) as well as a 10% to 30% deposit requirement, which is based on the total cost of the project.

Blanket loans

A blanket loan is a funding option that caters to investors with multiple properties. Essentially, these commercial loans allow borrowers to consolidate numerous mortgages into one. This makes payment easier and can reduce administration costs.

Another benefit of this type of loan has to do with construction — specifically the impact a lien can have on impending construction efforts. Frequently, if a builder or developer wants to undertake construction on a property under a mortgage, they’ll be unable to secure a loan due to existing liens on the property (e.g., the mortgage).

If the property owner has enough equity built up in other properties, they can exercise a release clause that removes the lien from the property in question.

These loans are available through traditional and commercial lenders, and an increasing amount of online lenders are beginning to offer blanket loans. If you qualify, you can typically expect terms between two and thirty years with rates between 4% and 11%.

How are commercial loan rates determined?

With the exception of hard money loans, most lenders base approval and rates on two primary factors: your business finances and your personal finances. If the loan is specifically for a real estate purchase, construction, or renovation, then the lender will also take into consideration the property for which the loan will be used.

When applying for a commercial loan, the lender will likely take into consideration your business credit score, which is used to determine risk — in other words, are you likely to repay the debt. Similarly, even though the loan is for your business, the lender will also take into consideration your personal credit score.  

For that reason, it’s best to check both your personal and business score before you apply for a loan. You can access both your personal and business credit scores at for free to get an idea of what you may qualify for.

Like personal loans, which take into consideration an applicant’s debt-to-income ratio, commercial lenders typically look to your company’s “debt service coverage ratio” when going through the credit approval process. This is determined by dividing your net operating income (NOI) by your total debt service, which includes the principal balance as well as the interest to be paid.

Depending on the type of loan, they may also ask to see documentation such as your financial statements, tax returns, business checking account statements, and more.

Using a commercial loan calculator to find the best lending option.

One of the best ways to ensure that you’re making the best decision as it relates to your real estate investment is to use a commercial loan calculator.

While there are numerous small business loans that can help you determine the general cost of a loan, a commercial loan calculator is designed to account for a specific variable, like amortization terms, balloon payments, and P&I payments.

In addition to comparing lenders, a commercial loan calculator will also allow you to compare various lending scenarios based on loan amounts, terms, and rates.

This article was originally written on June 11, 2019 and updated on November 21, 2019.

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Jennifer Lobb

Jennifer Lobb

Jennifer is a alum of the University of Denver. While in the graduate program there, she enjoyed spending time identifying ways in which non-profits and small businesses could develop into strong and profitable organizations that while promoting strong community growth. She also enjoys finding unique ways for freelancers and start-up businesses to reach and expand their goals.

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