What is a commercial loan?

The lender advances an agreed amount, or a limit you can draw on, and you repay it with interest over a term that suits the purpose. Pricing is usually a base rate plus a margin that reflects credit risk, loan size and the security on offer.

Repayments can be principal and interest, which reduces the balance each period, or interest only for a set window, which keeps early payments low but leaves the principal untouched until amortisation starts. Rates can be fixed for a period or variable, and breaking a fixed rate early can carry a material cost.

A commercial term loan is a fixed limit repaid over an agreed period, used for plant purchases, expansion or refinancing. A commercial property loan buys, refinances or develops income producing property and is normally secured over the title. A construction loan releases funds in progress draws as building milestones are met.

For working capital there is the business overdraft or line of credit, where interest is charged on the drawn balance, and invoice discounting or debtor finance, which advances against unpaid invoices. Equipment and vehicles are usually funded through asset finance, structured as a chattel mortgage, hire purchase or finance lease.

Security shapes pricing. Real property is taken by a registered mortgage, usually first ranking, while chattels and equipment are covered by a security interest perfected by registration on the Personal Property Securities Register, so it pays to search the PPSR for existing encumbrances. Corporate borrowers often give a general security agreement over company assets, and directors are commonly asked to stand behind the debt personally. Unsecured facilities carry higher interest and tighter conditions.

On the credit side, lenders weigh trading history and turnover, serviceability stress tested against higher rates and lower revenue, profitability, the loan to value ratio for the asset type, business and director credit files, the entity structure, and industry risk.

Expect an establishment or application fee, valuation and inspection costs, legal fees for mortgage documentation, PPSR searches and registrations, ongoing facility or account keeping fees, discharge fees, and break costs on a fixed rate loan, which can be material. Default interest and enforcement costs apply if repayments stop.

Interest on commercial borrowing is generally deductible when it is incurred producing assessable income. GST treatment varies with the structure, and a registered business may be able to claim GST credits on an equipment purchase. Depreciation is claimed over the asset's effective life, and which party claims it depends on the finance method. Check with your accountant or the ATO.