In the financial world, there’s a big difference between consumer loans and those that are issued to businesses. Consumer loans include things like mortgages, auto loans, boat loans, and even credit cards. Business loans, also known as commercial loans, can be much more complex and involve any number of different properties or pieces of equipment.
In this post, we’ll break down some of the differences between commercial loans and consumer loans and look at a few of the most popular types of commercial loans available today.
Consumer loans are issued to… consumers – but that isn’t the end of the story. People borrow money to buy homes, cars, boats, and build things. Consumer lending also encompasses revolving loans or debt, also known as credit cards. The application process is very thorough and while the requirements to get an individual loan will vary based on the lender, the road to obtaining a consumer loan can be difficult and lengthy. Why?Most individual loans aren’t made for huge sums of money, mainly because the types of things that people receive loans for aren’t of the same scope of those made for businesses.
Commercial loans differ from consumer loans in many ways. First, the amount of money involved in commercial loans is usually greater than those issued to consumers, because the scale of the projects that are being funded are generally much larger than those undertaken by individuals.
Unlike consumer loans that are covered by numerous federal and state financial protections and regulations, commercial loans do not have the same levels of protection. That doesn’t mean that the loans are unregulated or that they exist outside of the scrutiny, but it does mean that the law assumes that businesses are better equipped to understand the terms and requirements of the financial activities that they undertake.
We couldn’t possibly outline every type of loan a business owner might encounter in the marketplace, but we’ll tackle a few of the most popular here.
One of the most straightforward and most popular commercial loan products is installment loans. Once approved, a business receives all of their funds at one time and begins making payments. The amount owed is a calculation of the principal (actual amount borrowed) plus interest and any fees or other charges applied to the loan. The lender and borrower agree to a term (how long it takes to pay back) and other conditions.
In general, the term will be directly related to how the loan funds will be used and the interest rate may be affected by how risky the borrower appears to the lender. Once approved for the loan, the business can only use the funds from that loan for the specific purpose agreed upon in the loan application.
Many businesses refinance and pay off their loans early frequently, so banks and other lenders may choose to include an early payment penalty. This makes it more expensive for businesses to move their commercial loans around for the best deal and helps the lenders recoup some of their overhead costs in servicing the loans.
As a commercial loan product, lines of credit function similarly to how a consumer might think of a credit card. When a business needs funds and has an approved business line of credit, they can contact the bank and receive money almost immediately(as long as their requested amount is within the limits of their credit line). Unlike an installment loan or other commercial loan, a line of credit would not be used to finance the purchase of property or construction of a building. Business lines of credit are most often used to bridge the gap between revenue and expenses and should be viewed as a short-term solution to funding needs.
The flexibility that lines of credit offer makes them a popular option for emergency funds. They don’t typically have limitations on what the funds can be used for once the borrower is approved. Payments are not generally due until a withdrawal is made, so a borrower can apply for a line of credit and not worry about owing anything until they actually draw funds against the line.
Outside of the “big two”, there are several other types of commercial loans that a business might have access to, including:
As a business owner, the borrower must be aware of the benefits and risks of obtaining a commercial loan. As a vital financial tool to help start or grow a business, commercial loans are absolutely necessary in the economy today, but business owners can put themselves in a tough situation in a sticky situation if they are careless with their finances after receiving the funds. Many commercial loans require a personal commitment or guarantee from the business owner, which can lead to the loss of personal property and other assets if the business defaults on its loan.
Like any major financial decision, a business should weigh all of its options to determine if taking a commercial loan is the right thing to do. In many cases, obtaining funding from an investor or having the owner inject some of their own wealth into the business may be the best choice. Once the choice is made to pursue a commercial loan, taking the time to do research will save years of stress and potentially large sums of money down the road.