How Do Commercial Loans Work?

5 min read • May 09, 2021 • Barry Eitel

The commercial loan world is vast and can be overwhelming for small businesses, especially very new or very small operations. However, many companies have found commercial lending imperative for growth: a small business loan can be utilized for further expansion and greater earnings in the future. In other situations, a loan can help you keep your operations going when business is thin or protect you against dreaded cash crunches.

You’ll likely engage with small business lending at some point, so it’s important to understand how commercial loans work and what options are available to you.

What Is a Commercial Loan?

A commercial loan, or small business loan, is a loan provided to a business from a financial institution, typically a bank. In many cases, a commercial loan is secured by collateral, like equipment, vehicles, or property, and both parties agree to repayment terms before the loan is advanced.

“Commercial loan” is a generic term describing a whole industry of financial products, and the list keeps growing as new lenders enter the market—especially online. If you ask most small business owners about commercial loans, they’ll probably tell you about term loans, business lines of credit, or commercial real estate loans.

However, many small businesses also receive funding through commercial loan products like invoice factoring, equipment financing, merchant cash advances, or ACH financing. Many of these options are for smaller amounts and have shorter repayment periods than term loans.

Commercial loans are usually leveraged for a specific reason, like expansion. Some options, like invoice factoring or equipment financing, are tied to an asset, e.g. unpaid invoices or a piece of equipment respectively.

“Small business loans can be geared toward specific needs, like helping you expand your warehouse or start a franchise,” Alexandria White notes in CNBC. “There are also loans that can give you access to cash when you have a pile of unpaid invoices. Most small business loans are available through online lenders, banks, and credit unions. The interest rates, fees, loan limits, and terms fluctuate based on the type of loan, lender, and borrower.”

How to Get a Commercial Loan

Your company’s process for getting a commercial loan will depend on the type of loan, your creditworthiness, and your goals.

While there are similarities between most application processes, you should research the specifics for a commercial loan based on how much funding you desire and what sort of repayment terms suit you.

Do Your Research

Begin your search for commercial loans by determining your business’s needs, either from an expansion or financial standpoint. Then you should know what repayment terms your company can afford, the size of the loan you want, and what sort of lending products best fit your business. Beyond knowing this for yourself, you’ll probably have to articulate this information to the lender, too.  

Know Your Credit Score

As part of your research, you should know your personal credit score and, if applicable, your business credit score. Most lenders will want your personal credit score above 650. Your business credit score is based on your company’s creditworthiness, so it might not exist if your business is new.

Prepare Documents

Based on what a loan application requires, you should gather several documents. You should probably prepare a profit and loss statement, balance sheet, and cash flow statement. It’s likely that you’ll need to show bank statements, business licenses, and tax returns. Having a resume at the ready couldn’t hurt while applying for loans, either.

Devise Business Plans

Especially for large loans like a term loan from a bank, your application will rest largely on your company’s financial stability and your business plan. You should work on financial planning documents as part of your regular record-keeping practice, but you’ll need to develop them for a loan application. These documents show how you plan to use external funding to grow your company. Importantly, your business plan should show that you can repay the loan in question over the repayment period.

How Do You Qualify for a Commercial Loan?

To qualify for a commercial loan, you need to prove your creditworthiness and show that you can repay the loan. While each loan application is different, each lender is essentially looking for these 2 related qualities.

To prove your creditworthiness, you should have a high credit score and your business should have a solid cash flow. You should exude organization and hone your attention to detail. Fill out loan applications with precision and accuracy—sloppiness with your applications can make the whole ordeal a waste of time. Furthermore, don’t apply for a bunch of loans at once, as this can ding your credit score and raise red flags with lenders.

To prove that you can repay the loan, create a bulletproof business plan that shows how your business will fare during best-case, status quo, and worst-case scenarios. Have collateral to offer to secure the loan.

What Is the Minimum Down Payment for a Commercial Loan?

The minimum down payment for a commercial loan varies widely depending on the loan—many require no down payment. Generally, down payments are required for equipment, vehicle, or property loans. In many real estate situations, standard down payment requirements range from 15–35% of a property’s purchase price.

“The better your personal finances are up front, the more likely you are to be approved for a good loan option,” explains Jared Weitz, the CEO of lender United Capital Source. “Most loans require some form of down payment, and this is typically varied based upon the borrower’s financial history and the collateral put up for the loan. Based on this, most loans range from 0–20% down payment for the loan.” 

Many lenders like to see that you have some skin in the game, either with a down payment or some form of collateral. If no down payments are required, interest rates will probably be higher and repayment terms will likely be less favorable for you. 

Barry Eitel

Barry Eitel has written about business and technology for eight years, including working as a staff writer for Intuit's Small Business Center and as the Business Editor for the Piedmont Post, a weekly newspaper covering the city of Piedmont, California.