How Is the SBA 504 Loan Structured?
It’s important to realize the difference between a 504 loan and many other types of loans. For instance, with a home loan, your funds go specifically towards the purchase of the house and land on which it sits. It may also be used to pay some associated costs, and there are loan options that will al
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It’s important to realize the difference between an SBA 504 loan and many other types of loans. For instance, with a home loan, your funds go specifically towards the purchase of the house and land on which it sits. It may also be used to pay some associated costs, and there are loan options that will allow you to finance needed repairs and renovations into the project, too. In contrast, 504 loans are structured differently— and, in this article, we’ll discuss how.
We’ve already mentioned the unique contribution arrangement elsewhere on this site. The borrower will pay 10% of the loan as a down payment. The CDC will put up 40% of the loan’s value. An SBA-approved lender will then supply the remaining 50% of the value.
Let’s assume that you are taking out a loan for $1,000,000 ($1 million). The loan structure would look something like this:
You supply $100,000 as a down payment.
Your CDC supplies $400,000 – This is provided through a second lien, usually with a 20 or 25-year, fixed interest rate.
The lender supplies $500,000 – This is a first lien from a private sector lender.
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 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 such as real estate and equipment. The loan is also backed by the SBA, 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. Terms for SBA 504 financing are typically 10, 15, or 20 years, and the loan is fully amortized without a balloon payment.
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What are the terms of an SBA 504 loan?
The SBA 504 Loan Program offers loan amounts up to $5 million ($5.5 for manufacturers), with loan terms of 10 to 20 years (fully amortizing). Rates are fixed at Prime + 1.25% - 2.75%, and the loan to value (LTV) is up to 90% (80% on hotels and motels). The minimum debt service coverage ratio (DSCR) is 1.20x on existing cash flow, and the loan uses the project assets being financed as collateral, with personal guarantees from the principal owners. Fees are typically 3% of the debenture, which may be financed with the loan.
How much can I borrow with an SBA 504 loan?
The SBA 504 maximum loan amount is currently set at $5 million in lifetime dollars. However, if your business is a small manufacturer, you can borrow up to $5.5 million in lifetime dollars. It should also be noted that if you decide to embark on energy-related projects that fall under the “go green” heading, you can borrow substantially more. While all projects are capped at $5 million, you can ultimately borrow up to $16.5 million in lifetime dollars.
According to the SBA regulations, Investors are allowed to borrow anywhere between the minimum of $500,000 all the way up to $14 million — though investors would have to meet incredibly strict qualifications in order to be approved for this amount.
What are the fees associated with an SBA 504 loan?
The most common fees associated with an SBA 504 loan include the following:
- SBA Guarantee Fee: 0.5% of the loan’s total value
- Funding Fee: 0.25% of the loan’s total
- CDC Processing Fee: 1.5% of the loans total
- Closing Costs: Variable depending on loan amount
- Underwriting Fee: variable depending on loan amount
- Servicing Fees: Fees charged by the loan servicer over time, reducing in five-year increments.
- Prepayment Premiums: Penalties for paying off your loan early, reducing over time (only due if you pay off the loan early).
- Lender Participation Fee: A one-time fee charged to your conventional lender, equal to 0.5% of the first lien.
- Additional Fees: A number of other fees may be charged during this process, including recording fees, closing fees assessed by the title company, title insurance fees, attorney’s fees, and more.
In addition, there may be additional fees included in the final deal when pursuing an SBA 504 loan. Know that one-time fees may account for 2% to 3% of the loan amount. These costs are related to the large closing fees associated with these loans. This percentage may also include things like property closing costs and attorney’s fees.
There is also a packaging fee, which will be a total of $2,500 that should be paid once the loan has been submitted to the proper authorities. This is basically an assurance fee. It will be returned to the prospective borrower if the loan application is denied. It will also be refunded once the application is approved and the debenture has been funded. However, this packaging fee will be forfeited if the loan application is withdrawn before a decision is made.
Why the different liens? This arrangement is to protect the private sector lender and reduce the risk to which the lender is exposed. That allows them to relax their usually lending requirements and extend a loan to a wider range of business owners. Because the bank’s loan is the first lien, it will be paid off first if you default. Risk is also reduced because the lender is not financing 100% of the loan, but only 50% of the loan. The CDC is paid second, only after the first lien has been satisfied.
However, there are other considerations to be made here.
For instance, you will need to make sure that your project meets 504 program requirements. There are also lending eligibility requirements that must be met.
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