The Main Types of Commercial Loans You Should Know

Understanding the Main Types of Commercial Loans

There are a wide variety of commercial loans that are available for individuals and business owners. It can be overwhelming to understand the different commercial loan types, but here’s a simple and easy breakdown of the main ones you should know!

Bank Overdraft

A bank overdraft is a popular type of commercial loan that enables you to draw funds greater than what is presently available in the company’s bank account. The amount of the overdraft and the interest to be paid on overdrafts is usually decided on before to sanction. Bank overdrafts are considered short-term funding as it can be covered with a subsequent deposit.

Loan Term

A loan term refers to a commercial loan that needs to be repaid within a specified time frame. This is typically accompanied with a fixed interest rate at a monthly or quarterly repayment schedule, while also including a set maturity date. Term loans can be both secure (meaning that there is the provision of collateral) and unsecured. Since secured term loans have lower risk, they tend to have lower interest rates. Loan terms can be categorised depending on the repayment period:

  • Short term loan – repayment is less than one year
  • Medium term loan – repayment period sits between one to three years
  • Long-term loan – repayment period above 3 years

Letter of Credit

A letter of credit is a document that is provided by a financial institution that approves payment to a seller given that specific documents have been presented to the bank. This essentially makes sure that the payment will go through as long as the services are performed. In other words, a letter of credit guarantees to the seller that he or she will be paid according to the agreement.

Lease Financing

Lease financing refers to a commercial loan that allows individuals or companies to own and utilise certain assets in return for previously-set interim payments. This can cover medium to long-term financing periods. Under lease financing, the lessor purchases the asset and has legal ownership over it. At the end of the leasing period, the lessor would recover most (or even all) of the initial cost of that asset, including interest earned from rentals or installments paid by the lessee. On the flipside, the lessee can actually choose to acquire legal ownership of the asset by paying the final rental / installment, or making a final purchase price with the lessor. Over the leasing period, the lessor remains the owner, yet the lessee has control to use the asset.

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Credit: Active Pipe