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The SBA provides financing options for businesses to obtain access to capital to be used for commercial real estate, working capital, startup expenses, and business debt refinancing.
Except for disaster loans, the SBA does not make direct loans to businesses. Instead, SBA loans are made through intermediaries such as banks and Certified Development Companies (CDCs) that administer these loans. In order to obtain an SBA 7a loan, a small business owner would partner directly with a bank. To obtain an SBA 504 loan, a small business owner would partner with a bank and a CDC.
While Banks are a great first resource, it is helpful for small business owners to understand the difference between the SBA 7a Loan and SBA 504 Loan, to make an informed decision on which loan may be best for them. SBA loans typically preserve capital by providing flexible down payment options.
If a business owner is seeking working capital or financing leasehold improvements as a borrower, SBA 7a Loans funds that can be used for these items. However, if the financing involves buying a building, ground-up construction, building renovation, or the purchase of heavy machinery and equipment, then the borrower should consider an SBA 504 Loan to attain the maximum loan with fixed rate options.
The SBA 504 loan was designed as an economic development program for small businesses to finance commercial real estate for use in existing business operations through local certified development companies. The thought was that if business owners could acquire real estate with a low down payment and a fixed rate, it would allow them to grow their businesses. Meanwhile, the SBA 7(a) loan was originally designed for higher-risk loans; like the acquisition of a business, working capital, refinancing current business debt, furniture and fixtures, and leasehold improvements. Such loans are considered to be high risk because of very weak, limited, or even no collateral.
While the SBA 7a loan can be used for real estate purposes, this facility is often structured with a variable rate and may not provide the same cash flow savings and rate protection as the SBA 504 Loan. Be sure to ask your lender about SBA 504 Loans if your project contains real estate or heavy equipment.
The SBA 504 Loan Program offers borrowers a fixed rate for up to 25 years with a minimum down payment of 10%. Existing equity in the real estate can be considered towards the down payment when applicable. Additionally, SBA Guarantee Fees on the 7a loan vary based on the size of the project. However, with the SBA 504 loan, the fees involved stay flat as a percentage when the loan amount increases.
In regards to interest rates, the 7(a) loan typically has a variable rate. While such rates are historically low now, they are currently rising and will continue to do so making it a more expensive proposition. Some banks do offer fixed 7(a) interest rates for any term.
In addition, the 7(a) loan has the “All Collateral Available Test.” This is where a small business borrower typically must pledge all collateral available, including their personal residence, when there is a collateral shortfall. This test does not exist with a 504 loan.
From the perspective of a small business owner, the SBA 504 loan can be safer and better for the borrower’s bottom line, and can be an important tool for the growth of small businesses.