Can An SBA 504 Loan Be Assumed?

Many types of loans are not assumable. They must be paid off, or refinanced. However, there are some notable exceptions. Most FHA loans are assumable, for instance, but so is the SBA 504 loan. How does this work? Why would a business owner want to allow someone to assume their business loan?

What Does Loan Assumption Really Mean?

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Chances are good that you are familiar with a few loan-related terms – words like principal, interest, term, borrower and the like. Assumption is one of those terms that just isn’t used all that often in the world of lending, for many reasons. The process is actually pretty straightforward, though.

In this situation, you have two parties – a business owner with a 504 loan they want to offload, and a buyer who wants whatever it is that the owner is selling, usually the collateral that secures the loan, such as real estate, or heavy machinery. Assuming that the buyer meets all the qualifications and requirements, they would pay whatever the owner is asking, and then step into the loan and make the remaining payments on it.

That’s really all there is to the loan assumption concept. Of course, it is a bit more complicated in practice.

Why Consider Allowing Your Loan to Be Assumed?

Why would a business owner want to allow their loan to be assumed? Doesn’t this mean they would lose control over whatever collateral was used to secure the loan? Yes, it does, but that may not be a negative thing in all situations.

One reason a business owner might want to allow their loan to be assumed, and one that we have touched on already, is if they want to avoid the prepayment penalty on the loan. By allowing a buyer to assume the loan, they are able to get out from under those payments without being required to pay a prepayment penalty. Also, the new buyer is not on the hook for any prepayment penalties, either.

There are plenty of other reasons for a business owner to consider allowing their 504 loan to be assumed, including:

  • They no longer need the real estate, building, or equipment securing the loan.

  • They are moving their business location and are unable or unwilling to relocate the collateral.

  • They need to sell their business or their assets but want to avoid prepayment penalties.

  • They are downsizing their business and no longer require the collateral.

These are just a few examples of possible reasons a business owner would allow their loan to be assumed. However, why would a buyer want to assume a 504 loan rather than applying for such a loan on their own?

There are numerous reasons for this. Just a few possible explanations include the following:

  • Ability to purchase machinery for less than the cost of new.

  • Ability to purchase real estate for their own business interests.

  • Ability to purchase a building for their own business.

  • Ability to take advantage of lower fixed interest rates than are currently available on the market.

What Is Required to Assume an SBA 504 Loan?

You will find that assuming an SBA 504 loan is very similar to applying for one in the first place. However, there are some key differences that must be addressed, and there are requirements for the buyer interested in assuming the loan.

First, the current owner must determine how much money they will require upfront. This represents the equity they have built up in the real estate, machinery, or other collateral through regular loan payments. The individual assuming the loan will need to pay this amount upfront prior to assuming the loan itself.

Second, there is no such thing as automatic approval when it comes to assuming a 504 loan (or any other loan for that matter). The assumption must go through the SBA, and each one is handled on a case-by-case basis. In addition, the following requirements, steps, and conditions apply:

  • Proof of ongoing insurance on the collateral with the SBA named as mortgagee must be provided.

  • All loans must be current before an assumption can commence.

  • The person assuming the loan must meet the same eligibility requirements as any other borrower.

  • The assuming individual must have experience and management skills that equal or exceed those of the original borrower.

  • The assumption cannot have any negative impact on the collateral securing the loan.

  • The person assuming the loan must have the ability to pay the entire loan in full.

  • No collateral can be released during the assumption progress – all collateral will remain part of the loan and must be paid off by the individual assuming the loan.

  • The person assuming the loan must have good personal and business credit.

  • The assumption cannot cause any negative impact to the business in question.

  • The existing collateral should be of sufficient value to continue to secure the loan. If the value of the collateral is no longer enough, additional collateral will need to be put up by the person assuming the loan.

  • If there is any type of shortfall, the original obligors cannot be released from the loan. In this instance, the original borrower will be responsible for some of the costs of the loan even after it has been assumed. Paying the loan off avoids this.

  • SBA 504 loans can only be assumed once, and the new loan must include a “due on sale or death” clause to prohibit any future assumptions.

  • All parties involved must sign a written agreement that specifies the terms of the assumption.

  • Assumptions cannot include any sort of real estate contract in which the seller retains an interest in the property until a specific amount of money has been paid.

In addition to those rules and requirements, the SBA requires a wide range of forms and papers from both parties. These are as follows:

The new borrower (assuming the loan) must provide:

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  • A signed and dated letter in which they consent to the assumption of the loan.

  • As personal history statement, including one from all corporate officers (SBA Form 912).

  • A personal financial statement from everyone who will be listed as a new borrower (SBA Form 770).

  • A signed Borrower’s Consent to Verify Information and 3rd Party Authorization – note that all borrowers and guarantors must sign this.

  • Income tax returns for the last two years from all borrowers.

  • If the individual assuming the loan represents a corporation, SBA Form 160 must be provided.

  • If the new borrower represents an LLC, a copy of the company’s bylaws and articles of incorporation must be provided.

  • A balance sheet and P&L statement for the last 90 days must be supplied.

  • UCC lien searches of collateral/business assets dated within the previous six months.

The current borrower (seller) must provide:

  • A letter explaining the assumption, including an explanation of any cash paid to the seller by the individual assuming the loan. The letter must be signed and dated by all original borrows/guarantors (except in the case of death).

  • If one or more of the original borrowers or guarantors has died, a copy of the death certificate must be provided.

  • A list of all collateral currently secured by the loan, including an evaluation (tax assessment or appraisal) completed by a third party.

  • If applicable, court documents granting the assuming individual ownership of the estate must be provided).

  • SBA Form 770 (Financial Statement of Debtor) completed, signed, and dated.

  • A Borrower’s Consent to Verify Information and 3rd Party Authorization signed by all current borrowers and/or guarantors.

  • Tax returns covering the previous two years for all current borrowers (sellers).

  • If applicable, a completed buy/sell agreement.

A loan assumption letter created by the SBA for this specific purpose can be downloaded in PDF format here.

Pros and Cons of Assumable Loans

Now that we have looked at the nuts and bolts of the assumption process, we need to delve into the question of whether or not assuming a 504 loan is a good decision or not. There are actually pros and cons to both.

Pros:

  • Can avoid prepayment penalties

  • Can speed the sale of the business

  • Can provide a cost-effective solution for obtaining partial funding

  • Can provide easier approval of remaining financing by a third-party lender due to a lower loan-to-value ratio

Cons:

  • The CDC will charge a fee of 1% of the balance of the loan being assumed.

  • Only the CDC-provided funds can be refinanced – the conventional lender’s loan must be repaid. This means anyone assuming the loan will need to find another conventional lender to work with.

  • Assuming a 504 only offers partial financing. The new borrower must attain other financing to complete the process.

  • SBA 504 loans can only be assumed one time, meaning whoever assumes it must pay it off eventually.