Are There Prepayment Penalties with an SBA 504 Loan?
Consumers have received greater protection against prepayment penalties on mortgage loans in the past few years. However, the same protections do not extend to small business owners. The simple answer to the question of whether or not there are prepayment penalties with an SBA 504 loan is yes, the
Prepayment Penalties and SBA 504 Loans
Consumers have received greater protection against prepayment penalties on mortgage loans in the past few years. However, the same protections do not extend to small business owners. The simple answer to the question of whether or not there are prepayment penalties with an SBA 504 loan is yes, there are. However, it’s not actually quite so clear cut.
What is a prepayment penalty? Simply put, it is a fee that is charged to the borrower in the event that they pay off their loan before the term is up. It is a way of guaranteeing a specific amount of profit for the lender (or fees for the SBA) if the loan is paid off early and they do not receive the expected amount of interest. So, how much might you expect to pay if you were able to get out of your loan early?
According to the SBA, the prepayment penalty begins at 3% of the loan’s value in the first year, and then drops with each consecutive year, eventually reaching 0% in the 11th year (and all subsequent years). The example chart below shows how your penalty declines over time. Note that the prepayment percentage will vary based on the debenture rate for your loan/bond.
Year 1 – 3.00%
Year 2 – 2.70%
Year 3 – 2.40%
Year 4 – 2.10%
Year 5 – 1.80%
Year 6 – 1.50%
Year 7 – 1.20%
Year 8 – .90%
Year 9 – .60%
Year 10 – .30%
Year 11 – 20 – 0.00%
Keep Paying on the Loan: While it might not be ideal, one of the simplest ways to avoid paying a prepayment penalty is to simply pay on the loan until its maturity date. Understand that prepayment penalties only pertain if you pay the loan off early. If you do not pay it off early, there are no penalties to worry about. Yes, this does mean paying interest, but it may be more affordable than the prepayment penalty, or at least allow you greater liquidity during the loan’s life.
Refinance: Technically, a 504 loan is actually two different loans. The CDC funded part of the loan, but a conventional lender funded the remainder. You may be able to refinance the first position loan (conventional) and the SBA would be required to subordinate to that loan, allowing you to keep your 504 in place but allowing you to take advantage of lower rates or better options, while avoiding prepayment penalties altogether.
Assumed: Finally, you may be able to offload the loan to someone else. SBA 504 loans are assumable (more on this later). You could choose to sell the equipment or real estate securing the loan for the amount of equity you have in them, and the new buyer, assuming they qualify, would be able to simply assume the payments in your place. When this happens, you get out from under any potential prepayment penalty, but the buyer is also able to avoid prepayment penalties, as they are eliminated in the case of an assumed loan.
What are the terms of an SBA 504 loan?
The SBA 504 Loan Program provides up to $5 million ($5.5 million for manufacturers) in loan amounts with 10 to 20 year terms (fully amortizing). Rates are fixed at Prime + 1.25% - 2.75%. Loan to Value (LTV) is up to 90% (80% on hotels and motels) and Debt Service Coverage Ratio (DSCR) is a minimum of 1.20x on existing cash flow. Collateral for the loan is the project assets being financed and personal guarantees from the principal owners. Fees are typically 3% of the debenture and may be financed with the loan.
Sources:
- https://www.sba.gov/offices/headquarters/ofa/resources/4049
- https://sba504.loans/finding-a-lender/
- https://sba504.loans/sba-504-blog/certified-development-companies
- https://sba504.loans
- https://www.sba.gov/sites/default/files/articles/Loan_Chart_HQ_February_2017_Version_B_0.pdf
- https://sba504.loans/sba-504-blog/what-is-the-sba-504-loan
- https://sba504.loans/rates-and-costs/
- https://sba504.loans/down-payments/
- https://sba504.loans/sba-504-blog/sba-504-loans-vs-7a-loans
What are the benefits of an SBA 504 loan?
The SBA 504 loan program offers several benefits to businesses, including long-term, fixed-rate financing, lower interest rates and down payment requirements than SBA 7(a) loans and Express loans, and the ability to purchase fixed assets for expansion or modernization. The SBA also backs the loan, reducing risk for lenders who put up half the cost of the project. In the case of default, the private lender has first lien on project assets.
For more information, please visit the following sources:
What are the eligibility requirements for an SBA 504 loan?
In order to take out an SBA 504 loan, your business must meet the following eligibility requirements:
- Your business must be a for-profit organization.
- Your business must meet current SBA size standards.
- Your business’ net worth cannot exceed $15 million.
- Your business cannot earn 1/3 or more of its income from packaging SBA loans.
- Your business must earn an average of $5 million or less per year (after taxes, and only for the preceding two years).
- Your business cannot be engaged in any sort of passive or speculative activities.
Note that additional requirements may be placed by CDCs or conventional lenders. You can find a full list of eligibility requirements and other important information with the SBA here.
What are the repayment terms of an SBA 504 loan?
The repayment terms of an SBA 504 loan are 10 to 20 years (fully amortizing). The loan to value (LTV) is up to 90%, and the debt service coverage ratio (DSCR) is a minimum of 1.20x on existing cash flow. The principal owners are also required to produce personal guarantees.
Source: www.commercialrealestate.loans/sba-504-loan and sba504.loans/loan-requirements
Are there prepayment penalties associated with an SBA 504 loan?
Yes, there are prepayment penalties associated with an SBA 504 loan. According to the SBA, the prepayment penalty begins at 3% of the loan’s value in the first year, and then drops with each consecutive year, eventually reaching 0% in the 11th year (and all subsequent years). The example chart below shows how your penalty declines over time. Note that the prepayment percentage will vary based on the debenture rate for your loan/bond.
Year Prepayment Penalty 1 3.00% 2 2.70% 3 2.40% 4 2.10% 5 1.80% 6 1.50% 7 1.20% 8 .90% 9 .60% 10 .30% 11-20 0.00% The prepayment penalty will vary based on the debenture rate for your loan/bond. Additionally, you may be able to avoid paying the prepayment penalty altogether by keeping paying on the loan until its maturity date, refinancing, or assuming the loan. For more information, please visit https://sba504.loans/sba-504-blog/prepayment-penalties-and-sba-504-loans.
How does that affect you? Well, suppose you took out a loan for $2 million, and were able to repay that loan within three years, rather than the 20 years originally assigned. In that case, you would have to pay $48,000 on top of the loan amount and other associated fees. The same loan would cost you just $6,000 if you paid it off in year 10 rather than year three. 10-year term loans also have an accelerated declination of their penalty, with $0 penalty after year five.
The example above is rather simplistic. Your penalty will be different. It is actually calculated on the loan debenture rate, with the full debenture rate equaling the maximum prepayment penalty.
Can the Prepayment Penalty on an SBA 504 Loan Be Waived?
No, there is no way to waive the prepayment penalty on an SBA 504 loan. However, there are ways to avoid paying it altogether that do not require it to be waived. These are as follows:
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