UNDERSTANDING COMMERICAL CREDIT

Commercial credit is a vital tool for business owners at every stage—whether you are starting a new venture, expanding your existing business, or purchasing an established company. However, it’s important to understand how the process works and what lenders expect before seeking funding.

This guide provides an overview of commercial credit, common loan products, interest rates, fees, and key factors to consider when applying for financing. Additionally, for veterans, this guide will clear up some common misconceptions about available grants and specialized funding programs, as well as warn against predatory lending practices.

Contents

1. What is Commercial Credit?
2. Common Commercial Loan Products
3. What Lenders Expect from Borrowers
4. Interest Rates: Commercial vs. Personal Loans
5. Fees Associated with Commercial Loans
6. Startup Grants and Commercial Lending for Veterans
7. Predatory Lending and Online Lenders: Protecting Yourself
8. Preparing for the Loan Application Process
9. Special Considerations for SBA Loans

What is Commercial Credit?

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Commercial credit refers to loans or lines of credit provided by banks or other financial institutions for business purposes. Unlike personal credit, commercial credit is used specifically for funding business operations and growth.

Common Commercial Loan Products

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Term Loans

• Purpose: Used for a one-time investment such as purchasing equipment, real estate, or business expansion.
  • Terms: Typically repaid over 3 to 10 years with fixed monthly payments.
  • Interest Rates: Ranges between 6% to 12%, depending on the business’s creditworthiness and loan amount.
• Funding Example: Buying a piece of heavy machinery for manufacturing.

Business Line of Credit

• Purpose: Provides flexible access to cash, similar to a credit card, and is commonly used for working capital needs.
  • Terms: Revolving line that you can borrow from as needed.
  • Interest Rates: Typically range from 8% to 15%, higher for businesses with lower credit ratings.
  • Funding Example: Managing seasonal cash flow or handling short-term expenses.

Commercial Real Estate Loans

• Purpose: Specifically for purchasing or refinancing business real estate.
  • Terms: Can be up to 25 years, depending on the size of the loan.
  • Interest Rates: Typically range between 5% and 10%, depending on the property type, location, and business financials.
  • Funding Example: Purchasing an office building or storefront.

Equipment Loans

• Purpose: Designed for purchasing equipment that directly supports the business.
  • Terms: Loan is secured by the equipment itself, and the term usually matches the

equipment’s useful life.

• Interest Rates: Range from 6% to 14%, depending on the type of equipment and business credit.
  • Funding Example: Buying a fleet of delivery vehicles.

SBA Loans

• Purpose: Backed by the U.S. Small Business Administration (SBA), these loans offer more favorable terms and are popular for startups and small businesses.
  • Interest Rates: SBA loans usually have lower interest rates, ranging between 6% and 9%, depending on the type of loan.

Key Programs: SBA 7(a) Loan, SBA 504 Loan, SBA Microloan.

What Lenders Expect from Borrowers

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Capital Requirements

• Lenders expect you to have some capital to contribute. This is your equity in the business and demonstrates your personal investment in the success of the company.

Credit History

• Both your personal and business credit histories matter. Strong personal credit is particularly important for new businesses with limited or no credit history.

Experience and Business Plan

• Lenders want to see that you have relevant experience in your industry. A well- constructed business plan that outlines how the loan will be used and how the business will generate enough revenue to repay the loan is crucial.

Personal Guarantees

• Many lenders require personal guarantees from business owners, meaning you agree to be personally responsible for repaying the loan if the business defaults.

Collateral

Lenders may require you to pledge collateral, such as business assets or personal assets like your home, to secure the loan.

Interest Rates: Commercial vs. Personal Loans

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Commercial loans often have higher interest rates than personal loans due to several factors:

Risk Profile

• Lenders view businesses as riskier than individuals, especially startups or small businesses without a proven track record. The higher risk of default typically results in higher interest rates.

Loan Size and Complexity

• Commercial loans tend to be larger and more complex than personal loans. The due diligence required to assess a business’s financial health, collateral, and long- term viability contributes to higher interest rates.

Personal Guarantees and Collateral

• Lenders often mitigate their risk by requiring personal guarantees and collateral, which can impact the loan terms and interest rates. For instance, offering personal assets such as a home may help secure a lower interest rate.

Interest Rate Ranges for Commercial Loans:

• Term Loans: 6% to 12%
• Lines of Credit: 8% to 15%
• Commercial Real Estate Loans: 5% to 10%
• Equipment Loans: 6% to 14%
• SBA Loans: 6% to 9%

Fees Associated with Commercial Loans

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In addition to interest rates, borrowers should be aware of several fees that are typically associated with commercial loans. These fees can vary depending on the loan type, lender, and the complexity of the loan.

Origination Fees

• Purpose: This is a fee charged by the lender to process and set up the loan. It usually covers administrative costs such as underwriting and preparing loan documents.
• Range: Origination fees typically range from 0.5% to 3% of the loan amount, depending on the loan size and type.
• Example: If you borrow $100,000, an origination fee of 1% would be $1,000.

Application Fees

• Purpose: Some lenders charge an upfront fee to process the loan application, whether or not the loan is approved. This fee covers credit checks, document review, and other initial processing costs.
• Range: Application fees can vary from $100 to $500 or more, depending on the lender and the type of loan.
• Note: Not all lenders charge this fee, but it’s important to ask about it when applying.

Appraisal Fees

• Purpose: For loans involving real estate or equipment, lenders may require an appraisal to determine the market value of the collateral. This fee covers the cost of hiring a third-party appraiser.
• Range: Appraisal fees can range from $500 to $5,000 or more, depending on the complexity of the asset being appraised.
• Example: A commercial real estate appraisal for a building could cost $2,000, while an equipment appraisal might be closer to $500.

Closing Costs

• Purpose: These are miscellaneous fees that are incurred when the loan closes. Closing costs can include legal fees, document preparation fees, title search, and insurance.
• Range: Depending on the complexity of the transaction, closing costs typically range from 2% to 5% of the loan amount.
• Example: For a $500,000 loan, closing costs could range from $10,000 to $25,000.

Guarantee Fees (SBA Loans)

• Purpose: For SBA loans, the Small Business Administration charges a guarantee fee to cover the cost of providing the guarantee to the lender.
• Range: Guarantee fees range from 0.25% to 3.75% of the guaranteed portion of the loan, depending on the loan size and term.
• Example: On a $500,000 SBA 7(a) loan with a 75% guarantee, a 3% fee would be applied to the guaranteed $375,000 portion, resulting in a $11,250 fee.

Prepayment Penalties

• Purpose: Some commercial loans include a prepayment penalty if the borrower repays the loan early. Lenders charge this fee to recoup lost interest revenue.
• Range: Prepayment penalties can vary but are typically a percentage of the remaining balance. For example, it might be 1% to 5% of the loan balance if repaid within a certain time frame (e.g., the first 1-5 years).
• Example: If you have a $200,000 loan with a 2% prepayment penalty and repay it early, you could be charged $4,000 in fees.

Annual Maintenance or Service Fees

• Purpose: Some lenders charge an annual fee to maintain a business line of credit or certain types of loan accounts. This fee covers the cost of keeping the account active.
• Range: Typically $100 to $500 per year, depending on the size of the line of credit or loan product.

Startup Grants and Commercial Lending for Veterans

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As a veteran or service-disabled veteran looking to start or grow a business, you may have encountered misleading information about the availability of grants or specific lending programs for veterans. Let’s clarify these key points:

Misinformation About Grants for Veterans

There is a common misconception that there are grants specifically available for veterans or service-disabled veterans to start businesses. While there are some grant programs for veterans, these are often limited to specific industries, community-based initiatives, or nonprofits. Most federal or state programs, including those for veterans, do not provide free money for starting a business.

Startup Grants for Veterans

Though rare, there are a few legitimate programs and competitions where veterans can apply for grants, but they are competitive and often restricted to specific types of businesses. For example:

• StreetShares Foundation Veteran Small Business Award: Offers grants to veteran entrepreneurs through a competitive application process.
• Hivers and Strivers Angel Fund: Focuses on startups led by veterans from U.S. military academies.
• Patriot Boot Camp: Aimed at supporting veteran entrepreneurs in the technology sector.

Veterans should approach any “guaranteed grant” programs with caution, as there are often scams targeting those looking for funding.

No VA Equivalent for Commercial Loans

Unlike the VA home loan program, there are no commercial lending programs specific to veterans or service-disabled veterans. Commercial loans are generally evaluated based on the same criteria as loans for non-veterans, including credit history, business plan strength, and available collateral.

Self-Employment Assistance for Service-Disabled Veterans

For service-disabled veterans, there is an important program that can offer support for starting a business: Vocational Rehabilitation & Employment (Chapter 31), under the
U.S. Department of Veterans Affairs (VA). This program includes a Self-Employment Track designed to help eligible veterans:

• Develop a business plan
• Obtain funding for necessary equipment, inventory, and other resources
• Receive additional support for training and licensing requirements

To qualify, veterans must have a service-connected disability that creates an employment barrier, and they must be approved by the VA for the self-employment track. This is one of the few programs that provides funding specifically for business-related needs

Predatory Lending and Online Lenders: Protecting Yourself

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While there are many legitimate online lenders and alternative financing options, some veterans fall victim to predatory lenders who charge exorbitant interest rates or hide fees in their loan agreements. It’s essential to understand how to identify and avoid these practices to protect your business and personal finances.

What is Predatory Lending?

Predatory lending refers to unfair and often deceptive loan practices that burden borrowers with unreasonably high interest rates, hidden fees, or terms that make repayment nearly impossible. These lenders often target small business owners, including veterans, who may be in urgent need of capital or are unaware of the true cost of the loan.

Warning Signs of Predatory Lenders

• Extremely High Interest Rates: Be cautious of lenders offering interest rates significantly higher than market averages. Some online lenders may charge Annual Percentage Rates (APRs) as high as 50%, 100%, or more.
• Hidden Fees and Costs: Predatory lenders often include hidden fees that aren’t fully explained upfront. Always ask for a clear breakdown of all fees, including origination fees, closing costs, and prepayment penalties.
• Pressure to Act Quickly: Lenders who pressure you to sign immediately or threaten that the deal will disappear if you don’t act fast are red flags. Legitimate lenders will give you time to review terms and ask questions.
• Confusing or Vague Loan Terms: If a lender can’t clearly explain the terms of the loan or uses confusing language, be cautious. Make sure you fully understand the repayment schedule, fees, and total loan cost before signing.
• No Credit Check or Oversight: Some lenders will offer “no credit check” loans, which may sound appealing if you have credit challenges, but these often come with excessively high fees and interest rates.

Risks of Using Some Online Lenders

Many online lenders offer fast funding, but it’s important to carefully evaluate their terms and reputation. While some online lenders are legitimate and offer reasonable terms, others fall into the category of predatory lenders.

• High Interest and Short-Term Loans: Many online lenders offer short-term loans with high interest rates, which can put pressure on cash flow and make it difficult to repay. Small business owners who take out loans from these lenders often find themselves in a cycle of debt.
• Daily or Weekly Repayments: Some online lenders require daily or weekly payments, which can be burdensome for businesses with irregular cash flow. Ensure that the repayment schedule fits your business’s revenue cycle.
• Potential for Fraud: Be cautious of online lenders with poor reviews or a lack of transparency. Always verify that the lender is legitimate by checking their credentials and customer reviews.

Protecting Yourself from Predatory Lenders

• Research Lenders Thoroughly: Before agreeing to any loan, do your research. Look for online reviews, check the lender’s Better Business Bureau (BBB) rating, and verify their credentials.
• Compare Offers: Don’t settle for the first offer you receive. Compare interest rates, fees, and repayment terms from multiple lenders, including traditional banks, credit unions, and SBA-backed loans.
• Read the Fine Print: Always read the loan agreement carefully, including the fine print. Look for any hidden fees, early repayment penalties, or clauses that could increase the cost of the loan.
• Ask Questions: If anything is unclear, ask the lender to explain it in detail. A reputable lender will take the time to answer your questions and ensure you fully understand the terms of the loan.
• Seek Professional Advice: Consider working with a financial advisor or your VBOC business advisor to review loan offers and ensure you’re getting a fair deal. They can help you navigate the loan process and avoid predatory practices.

Preparing for the Loan Application Process

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Here’s what to expect during the application process:

Documentation Requirements

• Financial Statements: Up-to-date profit and loss statements, balance sheets, and cash flow projections.
• Tax Returns: Personal and business tax returns for the past 2-3 years.
• Legal Documents: Incorporation documents, business licenses, and lease agreements (if applicable).
• Business Plan: Detailed plan outlining your business, its market, growth strategies, and how the loan will be repaid.

Personal Credit Review

Lenders will assess your personal creditworthiness, especially if your business is new or does not have established business credit. It’s important to check your credit report and correct any errors before applying for financing.

Collateral Assessment

Be prepared for the lender to appraise any collateral you’re offering, whether it’s business equipment or personal real estate. The value of the collateral will influence the loan amount you qualify for.

The Role of Personal Guarantees

Most lenders will require a personal guarantee, especially if your business is a startup or lacks substantial assets. A personal guarantee puts your personal assets at risk, so it’s essential to weigh the potential impact before agreeing.

Special Considerations for SBA Loans

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The SBA offers several loan programs tailored to small business needs, but these loans also have unique requirements:

• Longer Application Process: SBA loans often require more paperwork and take longer to process than conventional loans. SBA 7(a) loans, for instance, typically take 45-60 days from application to funding.
• Lower Down Payments: SBA loans typically require less equity from the borrower, making them more accessible to startups or businesses with limited capital.
• Personal Guarantees and Collateral: The SBA often requires both personal guarantees and collateral, but the terms are generally more favorable than traditional loans.
• Guarantee Fees: SBA loans have a guarantee fee (discussed in Section 5), which is a one-time fee charged at loan origination to cover the SBA’s guarantee of the loan. Guarantee fees apply, ranging from 0.25% to 3.75%.

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