What is a Commercial Loan Agreement?
A commercial loan agreement refers to an agreement between a borrower and a lender when the loan is for business purposes. Every time a substantial amount of money is borrowed, an individual or organization must enter into a loan agreement. The lender provides the money, provided the borrower agrees to all the loan stipulations, such as a prearranged interest rate and specific repayment dates.
Loans come with an interest rate. The interest is essentially an additional payment the borrower must make on top of the principal (the amount the loan is for) for the privilege of being able to borrow the money.
Commercial loans differ in several ways from a traditional loans made to individuals. Read on to discover how.
How Commercial Loans Work
Commercial loans involve a borrower and a lender. The borrower for commercial loans is almost always a corporation or business.
Borrowing money under a commercial loan agreement requires the borrower to pay a set amount of interest that is specified explicitly within the loan terms. In addition, there are predetermined dates that the borrower is required to make payments toward the principal of the loan.
The most common reasons that a commercial loan is sought include start-ups looking to grow or established companies looking to expand. The key takeaway here is that lenders offering commercial loans are providing a significant amount of money to the borrower and face serious risks if the start-up fails to take off or the expansion doesn’t generate more money for the company.
Commercial loans can be secured or unsecured. The primary difference between the two is how the lender is able to mitigate the riskiness of the loan they offer.
Secured Commercial Loans
In order to obtain a secured business loan, the borrower must own a piece of collateral that can be used in the event that repayment isn’t made. For example, a company may use its building, a company vehicle, or a piece of machinery as collateral. The size and value of the collateral are determined by the amount of the loan and the specifications of the lender.
If the borrower fails to repay the loan, the lender is then entitled to take the collateral outright. Depending on the size of the loan, the lender may come out of it with a poor deal; however, gaining anything in return for a defaulted loan is better than getting nothing.
Secured loans are easier to obtain because of the collateral provided. This helps the lender mitigate the riskiness of the loan. It also typically means that the interest rate on the loan will be lower.
Unsecured Commercial Loans
Unsecured commercial loans are more difficult to come by because, as the name suggests, there is no security for the lender. Collateral is not required, which means that if the borrower defaults, there is little way for the lender to recover its losses.
Unsecured commercial loans typically require the borrower to have excellent financial stability, a good credit score, and a proven track record of paying off debts. Borrowers often need to fulfill more requirements in order to obtain an unsecured loan. Also, interest rates for an unsecured loan are substantially higher because the lender is taking on substantially greater risk.
CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following CFI resources will be helpful: