The United States Small Business Administration works with local lenders to give small businesses the affordable loans they need to operate. They have a number of loan programs to meet various business needs, including loans that cover real estate purchases. Borrowers will find it easier to be approved for an SBA loan than a regular bank loan and also enjoy better terms. This loan program also benefits the community at large, which enjoys a more robust local economy as a result of these programs.
SBA 504 Loan
This loan is for commercial real estate that will be occupied by the borrower. The 504 Loan program has concrete advantages for both lender and purchaser. The borrower gets a low down payment, usually just 10% of the total project cost. The loans range from $125,000 to $20 million and are for 20 years, though borrowers could apply for a 25-year loan beginning in April 2018. These loans are at a lower fixed rate, which keeps the monthly payments low and more affordable. Also, no outside collateral is necessary, although personal guaranties by the borrowers of 20% or more ownership are required.
Since the loan is a 40% SBA CDC loan (certified development company program) and 50% bank loan, the lender assumes second position, meaning they incur far less risk than with other loans.
The government does impose certain conditions on these loans. The 504 loan must be used for one or more of the following:
- To purchase an existing building
- To acquire land and then construct a new building
- To expand an existing building
- To finance building improvements
- To buy equipment
To be accepted for this loan, the borrower must have 51% occupancy for an existing building, 60% occupancy for new construction, and purchase equipment with a minimum 10-year economic life. The business net worth cannot exceed $15 million, and the average net profit after taxes for two consecutive years must not be more than $5 million.
SBA 7 (a) Loan
This loan has much in common with the 504 but differs in some significant ways. Unlike the 504, the loan structure is negotiable and additional collateral is necessary. In addition to the assets acquired by the financing, a pledge of the borrowers’ personal residence may be required. Both loans do demand personal guaranties by the borrowers of 20% or more ownership.
The program requirements are similar, but with the SBA 7, all assets financed by the loan must be used to the direct benefit of the business.
The loan can be used for the following:
- To expand, buy or start a business
- To purchase or construct real estate
- To refinance business debt
- To buy equipment
- To provide operating capital
- To purchase inventory
- To make leasehold improvements
This loan requires a 10% minimum down payment and is for businesses with annual sales of no more than $750,000 to $33.5 million for retail, service and agricultural businesses. The company must have between 100 to 1000 employees if it is a wholesale or manufacturing concern. The net worth allowed is determined by the industry type.
The interest rate is adjustable and the loan length is 25 years, generally making the 7(a) more expensive than a 504 loan, in part because the loans are sometimes more risky for the lender. The fees for these loans can be significantly higher than for the 504 and the maximum loan amount is $5 million.
Which is the Best Loan?
The 7(a)offers more flexibility as it can be used to borrow working capital as well as used for a real estate and business purchase. The 504 cannot be used for a business purchase or for working capital. Buying commercial real estate with the 7(a) is more expensive than using the 504, however. Also, there is more personal risk with the 7(a) since it usually involves using personal residences as collateral. If partners are involved in the purchase, the one with more equity in a home will carry more of the financial risk.
The 504 scares off some borrowers because it involves two lenders, and they fear the paperwork will be endless. In fact, most borrowers do not find that to be the case. In some incidences, completing the 7(a) takes longer. Also, the 504 comes with a prepayment penalty, but in most cases, the fees for the 7(a) still make it a more expensive loan.
Many lenders steer their clients toward the 7(a) since its more convenient for them and may be more profitable. For many clients, the 504 actually makes more sense.
For investors wanting to build or buy an existing building or business, one of the two SBA real estate loans might fit their needs. Borrowers may certainly consult with their current lender, but further investigation may be needed to find out which loan will work best for their particular situation. Both loans allow borrowers to get funding that might be out of their reach without SBA help. Lenders like both loan programs, in part because they face less risk from their loans. Current and future business owners can all benefit from these consumer-friendly financing programs.