What Are the Pros and Cons of the SBA 504 Loan Program?
SBA loans come with very low interest rates and terms that make them attractive to small business owners. Learn the pros and cons of the SBA 504 loan.
Benefits and Drawbacks of the 504 Loan Program
SBA loans come with very low interest rates, and beneficial terms that make them particularly attractive to small business owners who cannot find reasonable terms elsewhere. However, there are both pros and cons to these loans. In this article, we’ll review both the benefits and drawbacks of these loans to help you determine if an SBA 504 loan could be a good choice for your business.
What are the Benefits of SBA 504 Loans for Small Businesses?
Given that there are several different types of Small Business Administration loans available, not to mention conventional financing options out there, it makes sense to wonder exactly what benefits a small business could see from a 504 loan. Actually, there are quite a few that make this a very good option for almost any business.
Almost all small businesses in the U.S. will qualify: While the 504 loan program does have a wide range of requirements, almost all small businesses in the US will qualify for the program. However, realize that in order to qualify, your business must be beyond the beginning planning stages. That is, you must be ready to purchase property, invest in a building, or start construction of a new building, for example.
90% financing: The 504 loan program offers small business owners access to up to 90% financing for their project. This is more than most other options on the market. Even 7(a) loans from the SBA are only able to fund 85 – 90% of the project. Conventional loans fall below that mark (60 – 75% funding).
Longer amortization periods: SBA 504 loans offer longer amortization periods (10, 20, or 25-year terms depending on what is being financed), allowing you to spread your payments over a longer amount of time to reduce the amount paid per payment.
No balloon payments: 504 loans are not balloon loans. That is, you will pay on your loan without having to worry about making a very large payment at the end of the term. In this way, it more closely resembles a fixed-rate home mortgage.
Fixed-rate interest rates: While the interest rate on the loan will vary depending on the market at the time the loan is made, it will be made at a fixed-rate interest rate, below the current market, and will be fixed for the duration of the loan’s term (10, 20, or 25 years).
Cash savings: Conventional loans require that you pay around 1% of the loan’s value out of your own pocket in fees. Even 7(a) loans require that you pay between 2% and 3.75% of the loan amount out of pocket. The 504 loan requires that you pay a maximum of 2.65% of the loan’s value in fees, but those costs are included in the loan amount, meaning that you have only the down payment when it comes to out of pocket costs.
Low down payment: Speaking of down payments, the SBA 504 loan usually only requires 10% of the loan value down. A 7(a) loan will require between 10 and 15% down, and a conventional loan will require between 25 and 40% down. This makes the 504 loan the most affordable option available to most business owners. However, note that your down payment requirements will vary depending on your situation. We’ll discuss that in another section.
What are the Drawbacks of the SBA 504 Loan Program?
While there are plenty of benefits that make a 504 loan appealing, there are a few drawbacks that you should know about prior to deciding on a funding solution. Note that these drawbacks apply to all SBA real estate loans, not just the 504 program.
Application Process: The 504 program is not the most streamlined in the world, largely due to the need to have three parties involved. It’s not just you working with a lender, as it would be with a conventional loan. Both the CDC and the lender must agree on terms, and ensure that they are in compliance with SBA requirements.
Underwriting: All SBA 504 loan underwriting goes through a single office. As you can imagine, that sometimes leads to bottlenecks. However, the underwriters are also exceptionally thorough and will question anything that seems out of the norm, or that needs further clarification. The more questions or concerns the underwriter has, the more involved the lender, CDC, and you must be in the process.
Time: It should be noted from the outset that SBA real estate loans are not fast. In contrast to a home mortgage loan, which might close in just 30 days, it often takes around 60 to 75 days to close on an SBA real estate loan and receive your funding.
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What are the eligibility requirements for the SBA 504 Loan Program?
In order to take out an SBA 504 loan, your business must be eligible for the program. The eligibility requirements are pretty simple, though. In order to qualify, businesses must be for-profit enterprises, must not be above a certain size, and cannot be in engaged or involved in certain industries, such as lending money, gambling, speculation, or illegal activities. To help clarify things, we’ve created a quick and easy list to help you determine if your business qualifies for the program:
- 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
What are the advantages of the SBA 504 Loan Program?
The SBA 504 Loan Program offers several advantages for small business owners. These include:
- Low interest rates - SBA 504 loans typically have lower interest rates than other loan products, making them more affordable for businesses.
- Long-term financing - SBA 504 loans are typically amortized over 10, 15, or 20 years, providing businesses with long-term financing.
- Lower down payment requirements - SBA 504 loans typically require a lower down payment than other loan products, making them more accessible to businesses.
- Reduced risk for lenders - The SBA backs the CDC portion of the loan, reducing risk for lenders who put up half the cost of the project.
For more information, please visit https://sba504.loans/sba-504-blog/sba-504-pros-and-cons.
What are the disadvantages of the SBA 504 Loan Program?
The drawbacks of the SBA 504 Loan Program include:
- Application Process: The 504 program is not the most streamlined in the world, largely due to the need to have three parties involved. It’s not just you working with a lender, as it would be with a conventional loan. Both the CDC and the lender must agree on terms, and ensure that they are in compliance with SBA requirements.
- Underwriting: All SBA 504 loan underwriting goes through a single office. As you can imagine, that sometimes leads to bottlenecks. However, the underwriters are also exceptionally thorough and will question anything that seems out of the norm, or that needs further clarification. The more questions or concerns the underwriter has, the more involved the lender, CDC, and you must be in the process.
- Time: It should be noted from the outset that SBA real estate loans are not fast. In contrast to a home mortgage loan, which might close in just 30 days, it often takes around 60 to 75 days to close on an SBA real estate loan and receive your funding.
What are the maximum loan amounts for the SBA 504 Loan Program?
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.
Where the 7(a) has no minimum loan amount, the 504 has a minimum of $125,000. The maximum SBA 504 loan amount is between $5-5.5 million -- the SBA sets certain conditions a business can meet in order to qualify for $5.5 million, most of which are at the discretion of the SBA.
What are the repayment terms for the SBA 504 Loan Program?
The SBA 504 Loan Program has a loan term of 10 to 20 years (fully amortizing) and a fixed interest rate of Prime + 1.25% - 2.75%. The loan is fully amortized without a balloon payment. The principal owners are also required to produce personal guarantees.
For more information, please visit https://www.sba.gov/offices/headquarters/ofa/resources/4049 and https://sba504.loans/sba-504-blog/what-is-the-sba-504-loan.