The Pros and Cons of SBA Loans

SBA loans come with many benefits, including interest rate caps that keep loan costs affordable and a more lenient approval process relative to some other lenders. Some loans even include education and other resources for small businesses.

However, businesses must show that they’ve exhausted other financing options, and funding can take up to 90 days for some programs. An SBA loan may not be the best financing option for every business, and understanding the pros and cons can help you compare your options.

Quick look: SBA pros and cons

SBA loans are generally attractive to small business owners because of their guaranties and interest rate caps. However, drawbacks include long loan closing processes and collateral requirements.

What are SBA loans?

SBA loans are small business loans offered by private lenders and backed by the U.S. Small Business Administration. Eligible businesses can borrow between $500 and $5.5 million to fund almost any expense, though restrictions and limits vary by loan program.

The following key terms may help you understand how SBA loans work.

• Lending partner: An SBA-certified private lender that follows SBA loan guidelines for issuing loans and is eligible to sell the guaranteed portion of the loan to the SBA in the event of borrower default
• Preferred lender: An experienced SBA lending partner authorized to approve and underwrite loans for small business applicants without undergoing the full SBA review process, allowing for faster funding
• SBA guaranty: SBA loans are guaranteed, which means the SBA agrees to purchase a portion of the loan from the lender in the event of default, provided the lender has followed requirements. The SBA guaranty provides a backup plan for the lender, lowering their risk and allowing them to extend credit to more businesses.
• Personal guarantee: Business owners must agree to provide an unlimited personal guarantee when taking out an SBA loan, which means they can be held personally responsible for loan repayment if their business defaults.
• Base rate: The maximum interest rate for an SBA loan is equal to the base rate, which may be the prime rate or another published rate that changes with the market, plus a spread that varies depending on the loan amount and program.

Pros of SBA loans

1. Broad eligibility requirements

Businesses must meet the following SBA loan requirements to qualify:

• Registered, legal, for-profit enterprise
• Physically located and operating in the United States or a U.S. territory
• Borrower has sound credit that indicates an ability to repay
• Borrower has been unable to acquire funding from another financing institution

Some loans may require businesses to meet SBA size standards, which vary by industry and are based on the business’s annual revenue or number of employees.

Individual lenders also have their own requirements, which may be more or less stringent when compared to traditional loans. For example, banks may have lower credit score requirements for SBA loans. But they may also require a longer business history.

2. Businesses typically not approved for traditional loans could qualify

SBA loans are intended for businesses that do not qualify for other types of financing. Since the SBA guarantees a portion of loans issued by its partner lenders, lenders face less risk and can afford to have more lenient credit requirements while charging affordable interest rates. However, businesses still need a sound credit history to qualify.

Though an SBA guarantee lowers the risk for lenders, approval rates are slightly lower for SBA loans than traditional business loans and business lines of credit. About 34% of SBA applicants were approved in 2023, according to the Small Business Credit Survey, while 38% were approved for a business loan and 46% were approved for a business line of credit.

That said, some businesses may find it easier to qualify for an affordable rate with an SBA loan than a traditional term loan.

3. Capped interest rates

Interest rates on SBA loans are comprised of a base rate plus an additional percentage charged by the lender. The base rate is typically based on the prime rate, LIBOR or the optional peg rate, and it can change over time. Interest rates are subject to SBA maximums, which helps to keep SBA loans affordable for borrowers.

Maximum interest rates vary by program, and it’s important to compare each program against alternatives in the traditional lending space. For example, the median interest rate for business term loans issued in the fourth quarter of 2023 ranged from 7.98% to 8.86%, which is lower than the interest rate cap for SBA 7(a) loans. That said, online business loans can have interest rates as high as 60%. SBA loans may therefore be helpful for businesses with lower credit scores that might otherwise only qualify for high rates.

4. Small and large loan amounts offered

From $500 to $5.5 million, borrowers can secure funding for both minor and major expenses. As you learn about each loan program, be mindful of their respective restrictions. For example, you may obtain a CDC/504 loan of $5.5 million, but this money can only finance fixed assets.

5. Funds can be used for a variety of business purposes

You can use an SBA loan to cover almost any business expense, though permitted uses vary by program. SBA 7(a) loans are particularly flexible — you can use them to pay for:

• Buying or renovating real estate
• Working capital
• Refinancing other business debt
• Buying and installing equipment
• Buying supplies, furniture, or fixtures
• Facilitating a change of ownership
• A mix of purposes

6. Long-term financing options available

SBA loans come with terms up to 25 years. Traditional business term loans typically go up to 10 years, though some banks may offer longer terms, and many online lenders only offer shorter terms. A longer term means a lower monthly payment, which lessens the strain on cash flow. Just keep in mind that you’ll pay more interest over time with a long-term loan.

7. Resource centers available to provide assistance

The SBA offers resource centers that can provide business owners with general business assistance, SBA loan information and additional support for underserved communities. These resource centers can also assist with preparing the necessary paperwork when applying for your business loan.

Cons of SBA loans

1. Borrowers typically must make a down payment

You can expect to make a 10% to 20% down payment to secure an SBA loan in most cases (SBA microloans and disaster loans do not require a down payment).

This isn’t unusual for business loans — the down payment requirements on traditional bank business loans are generally higher, sometimes up to 30%. But many online lenders offer short-term business loans and lines of credit with no down payment.

2. Collateral could be required

Many SBA lenders will require borrowers to pledge assets as collateral. Though the SBA guaranty reduces risk, the lender may still require collateral and a personal guaranty from the borrower. Collateral gives the lender recourse, since they can seize the asset if the borrower defaults. Most SBA 7(a) loans up to $50,000 do not require collateral.

3. Personal liability if the business defaults

You’ll be legally responsible for repaying the debt in full and the lender has the right to seize any collateral you pledged if the loan defaults. If you still do not repay your outstanding balance, the SBA can send your debt to the U.S. Treasury Department for collections.

Though many traditional lenders require at least a partial personal guarantee as well, established businesses with a strong credit score may be eligible for a loan without a personal guarantee.

4. Slow approval process

The loan application process can sometimes take more than two months. When researching SBA loans, borrowers can consult their local SBA district office to be connected with the right loan program and SBA-approved lender. After the lender approves the application, they must then submit it to the SBA for a second approval, which lengthens the wait. To save time, work with a preferred lender with delegated authority.

If you need quick funding, you may prefer working with an online lender. Some online lenders offer short-term business funding as soon as the same day.

5. Poor credit applicants may not be approved

Businesses should aim for a credit score of 680 or better for the best approval odds, although some lenders may approve businesses with lower credit scores for some programs.

6. Prepayment penalties

SBA 7(a) loans are subject to a prepayment penalty if you prepay more than a quarter of your outstanding balance within the first three years. The penalty is equal to 5% of the prepayment amount during the first year and steps down for the years after.

504 loans have varying prepayment penalties during the initial years of the term. Microloans don’t typically come with prepayment penalties.

If you expect your business to earn enough revenue to repay the loan early, that’s an important consideration when comparing financing options, since some business lenders don’t charge prepayment penalties.

7. Typically not available to startups

Businesses younger than two years made up just one third of businesses approved for SBA 7(a) loans in 2023.

While the SBA 7(a) and 504 loan programs don’t have specific time-in-business requirements, they do require that your business be operating for profit at the time of your application, and lenders may have their own requirements. The SBA has few rules for the microloan program, allowing SBA-approved lenders to set the terms and requirements, so some intermediaries may offer startup funding through the program.

Types of SBA loans

7(a) loan program

The 7(a) loan is the SBA’s flagship product. The SBA guarantees up to 90% of the principal for 7(a) loans, which can be used for a range of business expenses, such as working capital, fixed assets and purchasing real estate. Here are the need-to-know details:

• Loan amounts: Up to $5 million
• Repayment terms: Up to 25 years
• Maximum interest rates: Prime + 8% fixed or prime + 6.5% variable, with lower caps for larger loans

The SBA also offers an Express program with a shorter timeline and loan amounts up to $500,000.

CDC/504 loan program

Under the 504 loan program, the SBA partners with Certified Development Companies (CDCs) to finance fixed assets, such as machinery, buildings or land. Funding for the loan comes from three entities: Up to 40% from a bank, credit union or another approved lender; 50% from the CDC (100% SBA-guaranteed); and, typically, a 10% to 20% down payment from the borrower. Here are the need-to-know details:

• Loan amounts: Up to $5.5 million
• Repayment terms: 10 to 25 years
• Maximum interest rates: Based on the 10-year Treasury rate; totals about 3% of the debt

Microloan program

SBA microloans offer smaller loan amounts administered by nonprofit community-based organizations. Microloans can cover a wide range of purposes, including working capital and machinery. Not-for-profit childcare centers are eligible in addition to small businesses. Here are the need-to-know details:

• Loan amounts: Up to $50,000
• Repayment terms: Up to 6 years
• Interest rates: Generally between 8% and 13%

Disaster loan program

The SBA offers disaster loans for businesses during emergencies, such as a declared federal disaster or economic injury. Unlike other SBA loans that partner with lending institutions, certain disaster loan programs are funded directly through the SBA.

The COVID-19 Economic Injury Disaster Loan (EIDL) and Paycheck Protection Program were disaster loans that have supported small business owners affected by the coronavirus pandemic.

Alternatives to SBA financing

If you decide that the terms of a small business loan from the SBA don’t suit your needs, consider these alternative financing options:

Traditional bank loans

Traditional banks offer term loans and business lines of credit for a variety of business expenses. You can also get a secured equipment loan or commercial real estate loan from a bank. Repayment terms and loan limits vary by loan product. You can typically find low interest rates when working with a traditional bank, but eligibility requirements may be more stringent than SBA loans. Small banks are more likely than large banks to work with small businesses.

Alternative lenders

Alternative lenders may offer faster funding and more lenient requirements, but they may also charge higher rates. Some financing options, such as merchant cash advances and invoice factoring, are not considered loans but can still be costly. Many alternative online lenders also offer shorter terms than SBA-certified lenders. However, you shouldn’t rule out alternative lenders when exploring your financing options — some businesses can get low-cost funding and other benefits from online lenders, and poor credit businesses or startups may find an alternative loan to be their only option.

Business credit cards

Business credit cards are ideal for business owners with a minimal operating history. If you were previously declined for a loan for insufficient credit, a business credit card could help you build your business credit score. In addition, business credit cards frequently offer various incentives, such as rewards on travel, dining and gas purchases. Some cards also come with a 0% APR introductory period, so you can avoid interest while you get your business up and running.

Crowdfunding

Small business owners may start crowdfunding campaigns to raise funds from a large number of people. Since you’ll likely need to market your campaign to raise funds, those with marketing skills and an existing online following are more likely to find success with crowdfunding.

Depending on which business crowdfunding platform you use, there often isn’t a minimum time in business or credit score requirement to starting a crowdfunding campaign. While crowdfunding sites typically don’t require you to repay the funds you raise, some crowdfunding platforms may collect a fee that’s a percentage of the total funds raised.