Commercial Loan Agreement: Definition & Key Terms | [Your Company Name]

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 rateInterest RateAn interest rate refers to the amount charged by a lender to a borrower for any form of debt given, generally expressed as a percentage of the principal.. 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 corporationCorporationA corporation is a legal entity created by individuals, stockholders, or shareholders, with the purpose of operating for profit. Corporations are allowed to enter into contracts, sue and be sued, own assets, remit federal and state taxes, and borrow money from financial institutions. 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 riskinessCredit RiskCredit risk is the risk of loss that may occur from the failure of any party to abide by the terms and conditions of any financial contract, principally, of the loan they offer.

Secured Commercial Loans

In order to obtain a secured business loan, the borrower must own a piece of collateralCollateralCollateral is an asset or property that an individual or entity offers to a lender as security for a loan. It is used as a way to obtain a loan, acting as a protection against potential loss for the lender should the borrower default in his payments. 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.

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Related Readings

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• Annual Percentage Rate (APR)Annual Percentage Rate (APR)The Annual Percentage Rate (APR) is the yearly rate of interest that an individual must pay on a loan, or that they receive on a deposit account. Ultimately, APR is a simple percentage term used to express the numerical amount paid by an individual or entity yearly for the privilege of borrowing money.
• Debt CovenantsDebt CovenantsDebt covenants are restrictions that lenders (creditors, debt holders, investors) put on lending agreements to limit the actions of the borrower (debtor).
• Debt DefaultDebt DefaultA debt default happens when a borrower fails to pay his or her loan at the time it is due. The time a default happens varies, depending on the terms agreed upon by the creditor and the borrower. Some loans default after missing one payment, while others default only after three or more payments are missed.
• FICO ScoreFICO ScoreA FICO score, more commonly known as a credit score, is a three-digit number that is used to assess how likely a person is to repay the credit if the individual is given a credit card or if a lender loans them money. FICO scores are also used to help determine the interest rate on any credit extended