Commercial Loans: What are the Different Types and How to apply?
May 24, 2021
What are Commercial Loans?
A commercial loan is a loan provided by the banks and financial institutions to the business. It is a debt-based funding arrangement. The purpose of these loans is to fund capital expenditures and/or pay operational costs and take them for the short term. Commercial loans are often suitable for small businesses due to regulatory hurdles, associated costs, and the time required is not feasible for them to access equity and bond markets.
Commercial loans can be used by businesses to serve purposes like acquiring assets, meeting operational costs, paying the employees, etc. However, the purpose of the loan applicant needs to be specified by the business.
Different Types of Commercial Loans
1. Term Loan
It is the most usual type of commercial loan. The term loans are taken for a specified period ranging from 1 – 20 years. For unsecured loans, the duration usually is less,i.e., up to 5 years, and the interest rate is high. Although, for a secured loan, the tenure can go up to 20 years as well, and the interest rate is also not very high. The interest rates are fixed, with a scheduled monthly or quarterly repayment.
2. Letter of Credit
Letter of credit is a document that serves as an assurance by the bank/ financial institution for the payment to the seller for the goods to be sold. This document serves as a promise to the seller. It is used for trade financing where the goods are sold overseas, and both the trading parties are not well known to each other.
3. Collateral Free Loan for SME
These types of loans are provided to SMEs without any collateral or third-party guarantee. The business can take these loans at both start-up or existent phases. The collateral-free loan for SMEs helps to purchase machines, carry out the expansion, or fund working capital requirements.
4. Equipment Loans
These are very specific loans that are taken by manufacturing units or construction units where the equipment costs are very high. To purchase the equipment, the most suitable loan amongst all the options is an equipment loan. The equipment itself serves as the collateral for the loan, and hence the interest rate is lower than the term loans.
5. Loan for Women Entrepreneurs
Some financial institutions provide special loan schemes for women entrepreneurs. These schemes include the flexible loan amount, reduced interest rates, faster processing, etc.
Benefits of Commercial Loan
1. Easy access to capital
A commercial loan provides easy access to additional capital, which may be used either for procurement of assets, or to fund operational expenses, etc.
2. Convenient application process
Even though it might seem that applying for a commercial loan is a demanding process, it is not. The process for commercial loan application is much easier than raising funds in the equity or debt market. The time taken, costs associated, and regulatory hurdles are more in the case of equity and debt markets.
3. Retain Ownership
By taking a commercial loan, the owner does not have to dilute his/her ownership. But if the owner issues equity to raise money, they have to let go of their equity in the business. The commercial loan does not make the owner lose their stake in the process of raising finance.
How to apply for a commercial loan?
The general process of commercial loan application consists of the following steps:
1. Pre-approval Qualifying Process
The lender at first begins with evaluating the financial history of the business. In addition, the lender also determines the existing debt and the purpose of the loan. Through this process, the lender tries to determine the borrowing capacity of the business.
2. Application of Loan
After the pre-qualifying stage, the owner of the business must complete the loan application and submit it. With the application, the other documents related to the firm, i.e., financial statements and similar documents, must be attached.
3. Loan application review
Once the loan application is submitted, the loan officer verifies the documents. The loan officer will review the credit history, collateral, current and projected income, etc.
4. Loan Committee
Once the documents are reviewed by the officer, it passes on to the loan committee. The loan committee further decides whether the loan will be approved or not. The owner, in this process, might have to provide additional documents.
5. Term Sheet
After approval by the committee, the loan processor presents the term sheet to the owner of the business. The term sheet contains details regarding the amount, collateral, use of the loan, interest rate of the loan. After signing the term sheet, third-party reports are generated.
6. Documents Closing
After the whole process, the complete application is sent back to the loan underwriter for final approval. After which, the business is needed to sign the final loan documents. The loan is then disbursed to the business.
A commercial loan is an easy way of raising finance for any type of business, be it SMEs, MSMEs, etc. These loans can be taken for the short or long term as per the convenience and paying capacity of the business.
Check out the whole range of business loans that can be taken at FlexiLoans. They provide loans across India to SMEs, MSMEs, Women Entrepreneurs, etc. FlexiLoans aims at solving quick and adequate funds problems for the business to expand and grow. The products of FlexiLoans range from term loans, Line of Credit, Vendor Financing, etc., and loans for each type of business and collateral-free loans.