It refers to a company that makes loans to commercial businesses or helps finance the sale of a company's products to its customers.3 min read updated on February 01, 2023
The definition of a commercial finances company refers to a company that makes loans to commercial businesses or helps finance the sale of a company's products to its customers.
Not all finance companies lend to commercial businesses, some lend to consumers. As finance companies do not take deposits from the public, they are not considered banks and thus are free from the strict regulations associated with banks. Instead, finance companies earn money from their own lending or from parent companies, which is then used to provide loans. Many finance companies base their loans on the value of the assets promised by their customers as security.
How Do Finance Companies Work?
Finance companies provide loans for their customers and typically have higher interest rates than those of banks. This loan interest is how finance companies generate revenue. Many people have poor credit history and will turn to finance companies to offer them loans. These clients offer collateral to secure their loans, typically by promising to give the finance company valuable person assets, if the loan is not repaid.
For example, if Stefano borrows $8,000 from a finance company to fund the launch of his cleaning business, the company may ask that he offer his personal vehicle as collateral. If Stefano fails to make his loan payments (as in, if he defaults on the loan), the company would take possession of his vehicle.
Types of Finance Companies
There are three primary types of finance companies:
- Consumer finance companies.
- Sales finance companies.
- Commercial finance companies.
The first category, consumer finance companies, makes small loans to consumers (individuals), typically with terms that benefit the company and are unfavorable for the consumer. Direct-loan and payday loan companies fall within this category and have a poor reputation for taking advantage of people who are struggling and in need of quick cash.
Consumer finance companies offer loans with higher interest rates than the market average, which are called subprime loans. Many states in the US have small-loan laws that prohibit consumer finance companies from charging interest rates of more than 25 percent.
The second category is sales finance companies, which are also called acceptance companies. These finance companies offer services for businesses in a similar way that direct-loan companies offer services for individuals, with some key differences. The businesses that borrow money from sales finance companies are typically large corporations with impressive credit ratings. A large corporation does not need to secure its loan with collateral. In addition, these businesses often receive better interest rates than they would receive from a bank.
The third category is commercial finance companies, also known as commercial credit companies. These finance companies offer loans to both small and large businesses, usually to help them pay for new equipment or other significant upgrades.
As small businesses pose greater risks to commercial finance companies, they often have to pay higher interest rates than larger businesses. These subprime loans' interest rates are usually between 0.1 percent and 0.6 percent higher than the loans given by banks to more qualified customers (prime rate loans). This may appear to be a small difference, but for finance companies, this translates into thousands of additional dollars in revenue. However, finance companies are more likely to have delinquent clients than a bank, so this extra money from paying customers helps mitigate these losses.
Commercial Finance Companies
Banks usually offer lower interest rates, more flexible terms, and higher loan amounts than commercial finance companies, so why wouldn't one choose a bank with whom to finance their business expenses? The primary reason is that banks are extremely tight with their credit. Only 20 percent of business owners who apply for loans through a bank receive the loan.
On the other hand, alternative lenders, such as finance companies, have much more flexible financing options that allow many small business owners to use their services. Not only do these lenders offer lines of credit and term loans, but they also offer merchant cash advances, invoice financing, short term loans, working capital loans, and much more. In addition, commercial finance companies work much faster than banks. Some might even approve a loan the same day you apply.
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