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Commercial finance is the area of the finance industry that offers commercial business loans. The word “commercial” is used to differentiate from investment banks. During the Great Depression, the Glass-Steagall Act was passed in 1933. The purpose of the Glass-Steagall Act was to limit banks’ activities to only engage in bank activities. A commercial bank could offer savings, checking’s and money market accounts. Activities of commercial banks, investment banks and insurance companies remained separate for 66 years. The Financial Modernization Act of 1999 repealed the Glass-Steagall Act. This allowed banks to consolidate. Now commercial banks can also participate in securities and insurance. Some financial experts argue that the repeal of the Glass-Steagall Act contributed to the financial meltdown of 2008.
Today, the two types of banks, commercial and investment no longer have to be separated because of The Financial Modernization Act of 1999. Therefore the term “commercial” usually refers to banks and financial intermediaries whose business is providing commercial business loans and other financial products to companies.
These loans are backed by some kind of collateral, usually:
Information on business financing that uses accounts receivable and equipment as collateral can be found in the Business Financing and Equipment Financing sections of this website, respectively.
The lender relies on the future cash flows of your business to repay the loan in an unsecured scenario. This type of business financing is addressed in greater detail elsewhere on business-money-source.com.
A commercial real estate loan or commercial mortgage is a loan to you that uses real estate as collateral to secure the debt. In this respect, a commercial mortgage is no different than a residential mortgage, except the collateral is a commercial building, strip mall, office building or some other business real estate instead of a house.
The borrower is also usually an entity other than individuals as in residential transactions. The borrower(s) may be a partnership, corporation or other legal entity.
You will want to get a commercial mortgage where the property is the sole collateral for the loan. This is known as a nonrecourse loan. If you default in repaying the loan, the lender can only foreclose on the subject property but cannot hold you or the other principles liable for any deficiency. You are well advise to verify state and local commercial real estate laws concerning nonrecourse and foreclosure with competent legal counsel, should you find yourself in a situation of loan default.
A typical commercial mortgage will have a 20 or 30-year amortization schedule. That means you will make monthly payments as if you are paying on a 20-year loan. However, the term will actually be much less, usually no more than 10 years but can be longer. At the end of the term, you will have to pay the balance of the loan. This is called a balloon payment. You will have to either refinance or sell the property in time to pay off the balloon payment. The advantage to this type of financing is that you will have much lower monthly payments until the balance is due.
Most commercial lenders will require you and the other principals to have a positive credit history even though this may not be the primary consideration for a commercial mortgage. The primary criterion for a commercial loan is the debt service coverage ratio. The debt service coverage ratio is the ratio of your company revenue available to the loan payment amount.
You will be expected to invest some portion of your own money into any commercial lending situation, “putting skin in the game”, as it were. The lender will apply a loan-to-value ratio to the amount you will be able to borrow. Generally the loan-to-value ratios for commercial properties are considerably lower than for residential properties. The current financial status of your business, as well as the type of business will have a significant bearing on the terms and amount of loan you will be able to acquire. Some lenders may restrict the use of commercial properties they make loans on. Some types of business may be excluded from consideration for funding altogether.
Since many funding sources specialize in certain kinds of businesses and certain types of properties, you will have to screen various lenders yourself or use a financial intermediary to find the right financing for your business.
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