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%

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:

• 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.

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