SBA 504 Loan Debenture Rate: How Is the Interest Rate Determined?

One of the major features and benefits of the Small Business Administration (SBA) 504 loan program is the ability to secure a 10- or 20-year fixed interest rate for owner-occupied real estate. After a 504 loan is approved by the SBA, the interest rate is not actually set until the 504 loan is funded. For all 504 projects, the third-party lender provides a interim bridge loan to cover the SBA portion of the financing during construction and/or acquisition. It is only after the project is totally complete, that a 504 loan can be closed. No money changes hands at that time. All Alloy Dev closed loans are submitted to the SBA where they are pooled with other 504 loans from around the country into a month debenture sale. All 504 loans are sold to private investors who actually put up the capital to fund the loans.

It is when the loan is submitted and put in this debenture pool that some of the components of the end interest rate are determined. For example, let’s look at a loan that was submitted for the July 2017 debenture sale. The starting point for pricing a 504 loan is the 10-year Treasury Bill rate. At the July pricing the rate was 2.38%. In order to attract investors, there is a negotiated interest rate spread over the Treasury rate. That is the interest the investors earn, which in July was 2.98%. The investors receive payment on a semi-annual basis while the borrowers make a payment each month. As a result of the different payment schedule, the note interest rate to the borrower is calculated. In July, the note rate was 3.03041%, and that interest rate is fixed for 20 years.

Added to the monthly principle and interest payment are two additional fees that are a calculated as a percentage of the initial loan amount: a borrower fee, currently at 0.697%, which is paid to the SBA; and a Certified Development Company (CDC) fee, which is paid to the CDC. The CDC must charge a minimum of 0.625%, although some CDCs charge more.

Example: $ 500,000, 20-year loan; 3.03041% interest rate; Payment: $2,780.50

$500,000 X 0.697= $3,485/12=$290.42
$500,000 x 0.625= $3,125/12=$260.52

The total monthly payment is $2,750.80+$290.42+$260.52=$3,331.34. This gives an effective interest rate of 4.612% for the first five years. The SBA and CDC fees are recalculated on the loan balance at the end of each five-year period. The payment, therefore, slightly declines after each fifth year of the loan term. When Alloy quotes an interest rate, that rate includes both interest and all fees in the monthly payment.

Some CDCs do charge a higher CDC fee as a component of the monthly payment. Alloy has always charged the minimum required by the SBA. So if a borrower is looking to do a 504 loan and talking to another CDC, be aware that they may be charging a higher CDC fee than what Alloy would charge.

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