he SBA supports two core programs used to finance commercial real estate — CDC/504 and 7(a) loans. It’s good to know the differences between these loan pro- grams to provide guidance for your client as they assess
which loan is best for their unique needs.
After 2009, lending requirements got much tighter, and small businesses, particularly those with shorter financial-performance histories,
are still considered a risky bet by many lenders. A higher perceived risk
will generally result in a higher interest rate for a loan. Short-term, fixed
or fixed-to-floating rates on conventional loans are the most common
interest rate options for small businesses.
In the case of the SBA, its 504 loan is designed specifically for commercial
real estate, while the 7(a) is a general-purpose loan. Both programs provide
a loan guarantee from the federal government. With a 504 loan, a bank
provides 50 percent of a project’s total cost, a CDC provides 40 percent and
the borrower contributes a 10 percent downpayment. This structure is attractive to banks because their risk is mitigated by the CDC’s participation
and the federal guarantee.
With the 7(a) loan, a bank receives a 75 percent loan guarantee from the
federal government for loans exceeding $150,000. So, if a loan is made for
$1 million and the borrower defaults for nonpayment, the bank can essentially return the loan to the federal government and receive a payment of
$750,000 on the $1 million loan. For banks, this mitigates having a large
sum on their books as a nonperforming loan, and it becomes a beneficial
tool in managing a bank’s balance-sheet and loan-loss reserves.
It’s important to be aware that in many cases bankers will recommend a
7(a) loan first, because banks earn larger income from fees than with a 504
loan. This creates a great opportunity for you to build trust with your client
and help them evaluate the best financing options to meet their specific
financing goals, rather than the bank’s.
Following are some helpful takeaways for the SBA’s two major loan-guarantee programs:
n Loan size. The SBA CDC/504 loan can finance projects of $20 million
and higher. The 7(a) loan limit is $5.5 million. Both loan types offer a
higher ceiling for manufacturers and other businesses that meet goals
around energy reduction or alternative-fuel usage. In fiscal year 2016,
the SBA approved more than 70,000 loans from the 504 and 7(a) programs, totaling nearly $29 billion.
n Rates and terms. The 504 loan offers a below-market, fixed rate set
at the time of funding. As of this past June, the 504 interest rate was
less than 5 percent for 24 consecutive months. The 7(a) loan most commonly features a variable rate, adjusted quarterly and negotiated with
your chosen lender. The 504 product offers a 20-year fully amortized
term. The 7(a) loan maximum is typically 25 years, but may also have
balloon features. Both programs also feature a 10-year term for large
n Collateral and downpayment. For a 504 loan, no extra collateral
is required. To comply with 7(a) loan standards, a bank will often require a client’s personal residence be used as collateral. Both programs
require a 10 percent downpayment from the borrower — 7(a) loans
may require more — which allows the small business to retain cash
for working capital and other needs. There is a clear advantage here
over conventional bank loans, which commonly require 20 percent to
25 percent equity.
n Loan structure. The structure of an SBA 504 loan is uniquely collaborative. A nonprofit CDC partners with a bank and the small-business
owner to assemble the financing package. As previously mentioned,
the lender injects 50 percent of the capital through a first mortgage,
the CDC provides 40 percent of the project cost with an SBA-guaranteed
second mortgage, and the small-business owner contributes a 10 percent
downpayment. This arrangement is attractive to many lenders, particularly
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with shorter financial-
are still considered a risky
bet by many lenders.”