Ravi Chandran
Commercial loan process is very different from the one for personal loans.
By: Hitesh Khan/
If you have never borrowed money for your business before, you may be in for a surprise. Whether you want to borrow working capital to expand your business or leverage equity in a commercial real estate venture, you will soon find out the commercial loan process is very different from the more common home mortgage process.
Commercial loan process is different as most commercial lenders are risk-averse.
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They charge higher interests rate than on a comparable home loan. Some lenders go a step further, scrutinizing the borrower’s business as well as the commercial property that will serve as collateral for the loan. This means that the business borrower should have different expectations when applying for a loan against his commercial property than he would have for a loan secured by his or her primary residence.
The following is a list of questions the borrower should ask himself and the lender before embarking on a commercial loan process.
1. How am I going to meet the loan repayment terms?
Typically, bank loans require the borrower to repay his or her entire business loan much earlier than its stated due date. Banks do this by requiring most of their loans to include a balloon repayment. This means the borrower will pay interest and principal on his 25-year mortgage at the stated interest rate for the first few years and then repay the entire balance in one balloon payment.
Many borrowers do not save enough in such a short time frame, so they must either re-qualify for their loan or refinance the loan at the end of the balloon term. If the business happens to have any cash-flow problems in the years immediately preceding the balloon term, the lender may require a higher interest rate, or the borrower may not qualify for a loan at all. If this happens, the borrower runs the risk of being turned down for financing altogether and the property may be in jeopardy of foreclosure.
A balloon loan has other risks as well. If the borrower’s business is in a “risky” industry at the time the balloon is due, the lender may back out of all refinancing for the enterprise. Alternatively, a lender simply may decide its loan portfolio has too many loans in a given industry, so he will deny future refinancing within that trade.
Non-bank lenders generally offer less stringent credit requirements for commercial loans. Some non-bank lenders will make long-term commercial loans without requiring the early balloon repayment. These loans, which may carry a slightly higher interest rate, work like a typical home loan. They allow a steady repayment over twenty or thirty years. It is often worth paying a one- or two-point higher interest rate for a fixed-term loan in order to ensure the security of a long-term loan commitment.
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2. How much can or should I borrow?
Most bank loans prohibit second mortgages, so the borrower should go into the loan process intending to borrow enough to meet current business needs, or enough to sufficiently leverage real estate investments. For a traditional acquisition loan in which the borrower is buying a new property, banks usually require a down payment of 25%. So for a $2,000,000 acquisition, the borrower will need to come up with $500,000 for the down payment.
Before you embark on a commercial loan process, remember that research has consistently shown that the number one reason behind the failures of most small businesses is the lack of adequate capital to meet cash-flow needs.
Because of this it may actually be safer for a small business to leave a larger cushion against unforeseen events by borrowing more money at the slightly higher rate.
The amount of the loan requested has an effect on which commercial lenders will fund the loan. Small businesses borrowing less than $2,000,000 will visit a different pool of potential lenders than those seeking loans of over $5 million.
Businesses owners ought to remember that you need to borrow when you do not need money. When your business is struggling and you need additional funding to tide over a tough patch, then you will find that your access to funding is completely cut off and end up with very expensive funding.
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