SBA loans are long-term, low interest rate loans for small businesses. The Small Business Administration (SBA) is a federal agency that provides various programs to assist the growth and development of small businesses. While the SBA isn’t the actual lender, they are responsible for setting up guidelines for their lending partners. They also guarantee part of the small business loan to reduce financial risk for their lenders.
If you’re in the process of starting your own small business or need to add funds to your existing business, acquiring a loan is most likely your top priority. While there are many loan options, small business loans that are guaranteed by the Small Business Administration are by far the most popular. Their popularity is largely due to the acceptance of small businesses that may not be able to meet all of the requirements needed for a traditional business loan. Since there’s a high demand for these small business loans, the application process can be quite lengthy. So, before applying for a Small Business Administration loan, make sure to review all of the programs the SBA has to offer and choose the right option for your business.
SBA 7(a) Loan
The option most people are familiar with is the SBA 7(a) loan. These SBA loans can be used for a variety of purposes including working capital, debt refinancing, marketing and advertising, hiring expenses, tools, equipment and resources for the business, franchises, and new construction – just to name a few.
Borrowers can take out SBA 7(a) loans up to $5 million, but must put down 10% and collateral. Loan terms can be as long as 10 years for general purposes and as long as 25 years for commercial real estate purchases. An SBA 7(a) loan is subject to fees that range anywhere between 3%-3.75% in addition to the interest rate, which typically ranges anywhere between 5.75%-8.25%.
An SBA 504 loan, or CDC loan, is used strictly for real estate and equipment purchases. This program is unique because it pairs a Community Development Corporation (CDC) with a lender in order to come up with the full loan amount. The pair will cover 90% (50% coming from the lender and 40% coming from a CDC) and the borrower is left with having to pay the remaining 10% in the form of a down payment. While this loan may not sound as beneficial as the SBA 7(a) loan, there is one advantage: the interest rate on 504 loans are fixed and lower.
Borrowers can take up to $5.5 million and have anywhere between 10-20 years to pay off the business loan. Similar to the SBA 7(a) loans, there are fees associated with the 504 loans. Another huge advantage to these Small Business Administration loans is that they do not require any collateral as the 10% down payment satisfies this requisite.
SBA Microloans are a great option for startups, small businesses with a couple of employees, and individuals who are self-employed. The SBA provides funds to nonprofit organizations with experience in lending who, in turn, lend the money to businesses. These intermediary lenders will loan up to $50,000, although the average amount for this type of SBA loan is about $13,000. Since the amount is so low, these business loans are considered short term. Borrowers can have up to 6 years to pay off their microloans.
Since the amount on these short term business loans tend to be low, the interest rate associated with microloans are typically higher than the other two Small Business Administration loan options. One advantage to the SBA’s microloan program is that the intermediary lenders are a bit more flexible with who gets approved. However, they have a tendency to be thorough in their approval process meaning there is a lot of paperwork and a long approval time.
Before you begin the application process, it’s generally a good idea to compare lenders and alternative lending companies that offer the type of SBA loan you’ve decided to take out. The SBA sets a limit on interest rates to protect borrowers from receiving a loan with extremely high rates. Taking time to compare rates across multiple lenders will help you find the most cost efficient loan for your small business.
Once you’ve chosen an SBA loan and funding partner to work with, it’s time to go through the application process. The first task is to gather all necessary documents that are required to apply for SBA loans.
In addition to the loan application, the SBA will require small business owners to complete a few forms. These forms collect the borrower’s basic information, a statement of the borrower’s personal history in order to evaluate character, and a personal financial statement.
The application process for Small Business Administration loans is one of their disadvantages not only because of the massive amount of paperwork, but also because of the time it takes to close these small business loans. The timeline takes the business owner through various stages resulting in a 2 to 3-month application process. By having all of the necessary information readily available to turn in to the lender, you can ensure that the process runs as smoothly as possible.
The SBA determines if a business is eligible based on what it does to receive income, the business owner’s character, and the business’s location. The Small Business Administration provides a detailed list of businesses that they would consider ineligible for SBA loans. If your type of business is not on that list, then you are eligible to apply for one of their loans. However, like all loans, there are still qualifications that must be met in order to be approved.
SBA-approved lenders, and lending companies, typically consider a small business to be qualified if they’ve been in business for at least two years, have at least $50,000 in revenue over the last year, and is profitable. Business owners with a personal credit score of 680 or more also have a better chance of receiving a small business loan guaranteed by the SBA.
Before starting the application process for an SBA loan, it’s important to understand the overall cost of these small business loans. The exact terms will ultimately be determined by the borrower and lender, but it’s helpful to have an idea of what items contribute to the overall loan amount. Remember that it’s possible to negotiate these terms with a lender.
The Small Business Administration guarantees a portion of SBA loans. However, there is a guarantee fee associated with this benefit that funding partners are responsible for paying. Unfortunately, they are given the option to pass this fee onto the borrower, which may be included in the overall loan amount.
If you plan on taking out an SBA loan that is under $150,000, the guarantee fee is waived. Any loan amount over $150,000 could be subject to a fee ranging from 3% to 3.5% of the guaranteed amount. The exact fee amount is dependent on the desired loan amount plus the length of the business loan.
For instance, if a borrower wishes to take out a $500,000 20-year loan, 75% would be guaranteed by the SBA. The lender or borrower would end up having to pay 3% of the guaranteed amount ($375,000) which would bring the guarantee fee amount to $11,250.
In addition to guarantee fees, the Small Business Administration typically adds an origination fee to the small business loans. This fee takes care of the lending company’s cost of making the loan available to borrowers. Origination fees are usually taken straight from the loan amount instead of being paid directly by the borrower. So, if the lender sets the origination fee to 4% and the borrower is requesting to take out $500,000, the borrower will only be receiving $480,000. Origination fees are not dependent on any of the loan’s factors, but are decided upon by the lending company themselves.
Interest rates on SBA loans are comprised of two factors: a base rate and an allowable spread. The base rate can be determined by one of three market interest rates: the current prime rate, the London Interbank One Month Prime (LIBOR) plus 3%, or the SBA Peg Rate. Since these interest rates change with the market, the base rate is also subject to change.
In addition to the base rate, the SBA allows lending companies an allowable spread. This means that lenders are allowed to add in their own rate in order to determine the final loan rate. Fortunately, the SBA sets a maximum spread so that lending companies don’t set SBA loan rates too high. The maximum spread is based on the length of the loan.
SBA loans that are set to be paid back in less than seven years will have a maximum spread of 2.25%. For loans that are scheduled to be paid back over the span of seven years or more, the maximum spread will be 2.75%. Using the same example as above, the $500,000 20-year SBA loan will have a base rate plus an allowable rate of 2.75% or less. The actual interest rate will be negotiated between the borrower and the lending company.