Commercial Loan: What Is It and How Does It Work?

To better understand what a commercial loan is, let’s look at a few examples from the major banks in Australia. 

With one bank, the minimum loan amount is $250,000, and the terms are from one to 25 years. They offer commercial loans at fixed and variable rates, with an optional redraw on the variable rate option. The loan can be secured with residential, commercial or rural property.

Another bank offers these loans starting at $1 million. Fixed and variable rate and principal and interest repayment options are available with this loan, with terms from one year to 15 years. The loan can be secured with a residential, commercial or rural property, or business assets. Flexible repayment options enable the business to match repayments with fluctuations in cash flow.

In addition to the interest rate, these types of loans have fees attached. This usually includes an establishment fee which is typically around $250.

Banks will require at least two years of financial statements as part of the application process. Given this requirement, this type of loan won’t be an option if you want funding to start a new business.

With high minimum loan amounts, these forms of commercial lending are unsustainable for small businesses needing funding requirements in the five-figure or lower six-figure range to improve cash flow.

To get a commercial loan, you will need to have a good reason and the financials to back it. Reasons for getting it can include buying commercial property or purchasing a business. Once you have a good reason for getting the loan, you need the financials to back it. This includes providing financial statements and showing that there is a business case for the loan. If it’s to purchase commercial property, you would need to show the financial returns from the purchase. For buying a business, you would need to show the financials of the business to show that it’s viable and will provide enough cash flow to make the loan repayments.

There are a variety of reasons for getting a commercial loan. This could be to hire more staff, buy new equipment, purchase a commercial property or purchase an existing business. As with other loans, the lender will want to know what the funds are for and how they will impact the bottom line.

These business loans are often used for buying commercial property, such as office, industrial or retail space. Investing in commercial property tends to be riskier than investing in residential property, so banks will consider a range of factors before granting commercial property loans. This is because commercial properties have higher vacancy periods than residential properties. In addition, commercial properties can have very high maintenance costs. These risks influence each bank’s lending criteria when considering loans for commercial property.

Commercial loan interest rates vary according to whether they are fixed or variable and whether they are secured by residential or commercial property. At the time of publishing, interest rates on residentially secured variable-rate commercial loans ranged between 7.4% and 8.2%.

The fact that commercial loans are tailored to medium and large businesses means that small businesses need to look for an alternative to this form of commercial finance to match their objectives and financial situation. Here are a few Australian credit alternatives:

• Business overdraft – a business overdraft is linked to your regular business transaction account and enables you to have a negative balance on your account up to an agreed limit. The minimum amount for a business overdraft is usually $10,000. With a business overdraft, you pay interest only on what you borrow. In addition, fees and charges apply such as establishment fees and ongoing line and accounting fees. A business overdraft can be unsecured or secured with your property. You will pay a higher interest rate with an unsecured business overdraft. Unlike most other credit products, a business overdraft can be withdrawn by the lender at any time. This means you could have to repay what you are borrowing when you need it most.
• Business lines of credit – a business line of credit is like a business overdraft but not automatically connected to your regular business transaction account.
• Invoice finance – with this type of finance, outstanding invoices are used as collateral for the loan. In some cases, the invoice finance company will take over the collection function. The borrower pays a small percentage of the value of invoices to pay for the loan.
• Credit cards – this can be an expensive way to fund your business if you maintain a balance for a long time. Credit cards are available in personal and business versions. Getting a business credit card is recommended for business purposes, although some entrepreneurs have started by using credit cards.
• Unsecured online business loans – these types of business loans are growing in popularity for several reasons. One is that it’s fast and straightforward to apply. Financial technology (fintech) companies use advanced technology to facilitate the application and approval process. With Moula, for example, the application can be completed in under 10 minutes.

Be sure to read the fine print of any financial product or service, including commercial finance. This includes understanding the specific criteria that apply and the fees and charges associated with a business loan.

Learn more about unsecured business loans from Moula and use our commercial loan calculator.