The Loans Canada team sits down with Gary Schwartz of the Canadian Lenders Association to talk about open banking.
Commercial Equity Lines Of Credit (CELOC)
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No matter where you establish it, there’s no denying how difficult, time consuming and expensive it can be to start a business. Even a small business could require tens of thousands of dollars in financing and countless hours of labor before you see any real profit for your efforts, which is why it’s good to always have some extra capital on-hand.
After all, not only can regular access to capital help you pay off expenses, it’s one of the best ways to grow and expand your business. The only problem is that qualifying for that kind of capital is tough, especially for small companies. If that’s the case, don’t worry, because a commercial equity line of credit (CELOC) may be the perfect option.
What Is A Commercial Equity Line Of Credit (CELOC)?
Buying commercial assets for your business allows you to build equity over time. The more real estate value those properties retain, the more commercial equity you have. For instance, if you buy commercial real estate in a desirable area, then renovate and diversify the property, you can increase its market value and gain additional equity.
Essentially, a commercial equity line of credit, otherwise known as a “CELOC” allows you to leverage that equity as collateral, in exchange for a set limit of revolving capital.
Types Of Property Accepted As Collateral For A CELOC
In Canada, different business lenders accept different kinds of collateral as security for the credit they’re about to extend. They then become a co-owner of the asset until you’ve paid what you owe, whether it be a loan or a revolving monthly credit line.
Although some lenders will take other types of valuable assets, such as vehicles and heavy equipment, commercial equity lines of credit (CELOC) normally have to be secured against real estate properties, including but not necessarily restricted to:
- Undeveloped land
- Warehouses & storage facilities
- Office & retail spaces
- Residential housing units (multi-family, etc.)
This is why you’ll often hear a commercial equity line of credit referred to as a:
- Commercial property line of credit
- Commercial real estate line of credit
- Land equity line of credit
- Real estate line of credit
- Small business equity line of credit
How Does A Commercial Equity Line Of Credit (CELOC) Work?
Similar to a home equity line of credit (HELOC), a commercial equity line of credit allows you to withdraw cash in whatever amounts you want, up to a specific monthly credit limit. You’re then left with monthly balance payments, with the option of making minimum or partial payments and you only need to pay interest on what you owe.
Unlike a HELOC, however, lenders won’t accept personal assets, like your house as a collateral. Instead, your company has to leverage its business properties. On top of that, your business must maintain a 0% debt balance for a certain period each year. These kinds of issues are why it can be much tougher to qualify for a CELOC than a HELOC.
As mentioned, the more equity your commercial assets have when you leverage them, the more funding lenders will normally let your business to borrow. Keep in mind that your company must fully own an asset’s title before it can officially be used as collateral.
CELOC Vs. Commercial Equity Loan
Depending on what type of business you’re running and what lender you apply with, you may have the option of applying for a commercial equity line of credit and a commercial equity loan, which are similar but different in many respects. Here’s how:
- Commercial Equity Line of Credit – Like a credit card, a CELOC gives your business access to an open-ended steam of revolving capital. You can dip into those funds and repay them as needed, rather than having a set amount that you must repay by a specific date. This makes the CELOC a good option for ongoing costs, such as renovations.
- Commercial Equity Loan – This loan also gives your business access to fast cash by using its equity as security. However, you’ll instead borrow a specific amount of money, then repay it in installments over a predetermined period. The size, number and frequency of your payments is set beforehand as well, so a commercial equity loan is better for singular costs, like paying off large debts.
While the length of your CELOC or commercial equity loan term will be decided by your lender, a CELOC often comes with a longer, more flexible term. That said, some lenders will switch your CELOC to a commercial equity loan after about 5 to 10 years.
Check out these 5 ways to improve your business cash flow.
Benefits Of A Commercial Equity Line Of Credit (CELOC)
Borrowing any commercial credit product can come with serious financial risks for your business, so it’s important to make sure that the pros outweigh the cons for you and your enterprise. For example, here are the most notable benefits of a CELOC:
- Fast Access to Cash – One of the best things about a CELOC is that it gives your business a revolving credit line that it can withdraw from when necessary, just like a credit card, HELOC or personal line of credit. The stronger your business is and the more commercial equity it has, the more credit it can access.
- Low Costs – If your business has good credit, a decent revenue and acceptable debt levels, it may score a lower interest rate than other credit products can offer. The lower your interest rate and fees are, the more money your business will save over time, especially since interest only applies to your expenditures.
- Great For Emergencies – When your business encounters a crisis, like a major breakage, financial loss or other disaster, it can be a huge relief to have a CELOC as a security blanket. Even a simple fix can cost hundreds, maybe thousands of dollars and your business insurance won’t cover everything.
- Can Cover All Kinds of Expenses – Because commercial equity lines of credit have flexible terms and credit limits, you can use one to finance almost any singular or ongoing business expense that comes your way, such as repairs, purchasing and updating your inventory, advertising, covering costs between accounts receivable, paying your employees, and buying uniforms or other necessities.
Drawbacks Of A Commercial Equity Line Of Credit (CELOC)
Despite all the benefits of a commercial equity line of credit, it’s equally important to consider the downsides involved, as they can have a definite negative impact on your business if you’re not careful. Here are some of the biggest drawbacks of a CELOC:
- Your Collateral is at Risk – Don’t forget, a CELOC means that your commercial equity will be co-owned by the lender until your term ends and all payments have been made. So, if you miss too many payments, your lender will have the legal right to seize your assets, on top of the extra interest and penalties they charge.
- Tendency to Over Rely On Funds – Although a CELOC can be useful, it comes with the same risks as any revolving credit product, so your business could rack up some serious high-interest debt over time. Normally, this becomes more of an issue when you continually make late, partial or minimum monthly payments.
- High Fees May Apply – Some lenders also charge high fees for any services, including administrative work and cash origination. Late penalties can apply when payments are missed too. The initial quote won’t be the actual cost of your CELOC, so remember to read your contract and calculate all costs beforehand.
What Costs Could Be Involved With A CELOC?
Some significant costs could apply to your CELOC in the form of:
While CELOC interest rates are sometimes lower than they are with other business financing products, they can still add up over your term. This is particularly true if your business doesn’t always make full, timely payments or if it has poor financial health, a low credit score or high debt levels when you apply.
A trustworthy business lender should list any potential fees somewhere on their website or product agreements. However, those fees can be charged for just about any service or problem that occurs, including but not limited to:
- Origination Fees – A one-time fee of around 1% that lenders may tack on at the beginning or end of your term for procuring the available funds.
- Annual Fees – A percentage of the borrowed amount will also be added to the final balance each year (some lenders waive this fee for the first year).
- Prepayment Fees – Though this is more of a problem with commercial equity loans, many CELOC lenders do penalize you for early payments.
- Penalty Fees – Late, incomplete and missed payments can all lead to stiff penalties. They can also hurt your business credit history and credit score.
What Are The Requirements To Apply For A CELOC?
Like the payment conditions of the CELOC itself, approval requirements can vary depending on the lender you apply with. Nonetheless, most business lenders will inspect the following elements before they approve or deny your application:
- A brief history of your company and its employees
- The current and future state of your business revenue
- The health of your business credit report, history and score
- The amount of outstanding debt your company has at the moment
- Information about any majority owners of the business
- The large expenses it will have to cover in the coming months/years
- The total market value of your company’s assets/equity
In some cases, anyone who has more than a 25% stake in the business will qualify as a co-owner and must therefore apply with you (at least 50% – 60% ownership needs to appear on the application). Don’t worry, because most lenders will provide a list of all personal or financial documents that are necessary. This checklist could include:
- Social Insurance/Security Number
- Business information (start date, identification number, type, etc.)
- Government photo identification (passport, driver’s license, etc.)
- Contact information (name, province/territory, address, etc.)
- Latest business bank statements (proof of income/revenue)
- Taxpayer information (income tax returns from the past few years)
- Details about your properties/assets (type, usage, etc.)
- Payroll information (number of employees, salaries, etc.)
Should You Get A CELOC For Your Business?
It’s no secret that building a business can be an exhausting and costly process. That’s why a commercial equity line of credit could be the perfect solution for you. On the other hand, there are some important costs to consider and the drawbacks may not ultimately be worth the effort, so make sure to speak with a financial advisor and a legal representative before you commit to a CELOC in Canada.
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