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The SBA 504 Loan Program Explained

Jun 12, 2020 by Liz Brumer

If you're a commercial real estate investor or small business owner in need of financing, you may benefit from a specialized loan program called the SBA 504 loan. These long-term loans are designed for helping new and growing businesses acquire financing to expand, make capital improvements, or even purchase new commercial real estate.

Learn what an SBA 504 loan is, how it works, who is eligible for the 504 loan program, and how the 504 loan compares to other SBA loan programs.

What is an SBA 504 loan?

An SBA 504 loan is a long-term loan issued through a nonprofit corporation called a Certified Development Company (CDC) and third-party lender, which is overseen, authorized, and regulated by the Small Business Administration (SBA).

How does an SBA 504 loan work?

The structuring of an SBA 504 loan will vary on a loan-by-loan basis; however, SBA 504 loans designate funding through a specialized loan structure:

  • Up to 50% as a bank loan conveyed as a conventional first mortgage.
  • Up to 40% as a CDC loan, which is backed by the SBA and conveyed as a second mortgage.
  • 10% to 20% down payment by the borrower or business owner.

Funding for an SBA 504 loan starts at $125,000 and is capped at $5 million, although certain businesses, such as energy projects, can receive up to $5.5 million or more. Loan proceeds can be used for the following purposes:

  • To fund fixed assets:
    • Furniture.
    • Existing facility or piece of real estate.
    • Machinery.
    • Equipment.
    • Leasehold improvements.
    • Ground-up construction.
    • Expansion or renovation costs.
  • For working capital:
    • Seasonal financing.
    • Export loans.
    • Revolving credit.
    • Refinancing business debt.

SBA 504 loans are usually fixed-rate loans that can span as long as 25 years, depending on what the funds are being used for.

Who is eligible for an SBA 504 loan?

The goal of the SBA 504 loan program is to provide small businesses with long-term financing (10-, 20-, or 25-year loan term) at competitive rates that promote economic growth and job creation. This means only for-profit businesses that operate in the United States are eligible for a 504 loan.

Applicants must have invested interest or equity in the company and be able to prove how the loan will stimulate economic activity or help retain or create jobs. Additionally, the applicant's tangible net worth cannot exceed $15 million, and the business's average net profit after taxes for the past two years cannot exceed $5 million.

CDCs and the SBA have defined eligibility qualifications, which are described above, but any participating lender has the right to designate their own eligibility requirements that may go above and beyond the SBA 504 program.

It's important to note that any principal owners, which are those with a 20% or more equitable share in the business, are required to provide a personal guarantee as a part of the 504 program.

How does the SBA 504 loan differ from the SBA 7(a) loan?

The 504 loan is not the only loan program offered by the SBA. The SBA 7(a) loan is another loan program offered through the Small Business Administration, although it is suited for different business needs than the SBA 504 program. At first glance, it may be difficult to understand which program is right for you, so let's take a look at how they differ.

Loan SBA 504 SBA 7(a)
Eligible business size Net worth of $15 million or less.Average net profit after taxes for the past two years should be $5 million or less. Annual sales cannot exceed $750,000 or $33.5 million for retail, service, or agriculture industries.100 employees or fewer, or 1,000 employees or fewer for a wholesale or manufacturing business.
Loan term 10 years for an equipment loan.20 or 25 years for real estate.Prepayment penalty. 10 years for a business acquisition or equipment loan.Up to 25 years for real estate.5 to 7 years for working capital.Prepayment penalty.
Interest rate Fixed rate. Almost always variable.
Proceed use Purchase an existing building.Land acquisition and ground-up construction.Improve, repair, or expand existing building.Equipment purchase.Working capital.Leasehold improvements. Expand, acquire, or start a business.Purchase an existing building.New construction.Refinance existing business debt.Equipment or inventory purchase.Working capital.Leasehold improvements.
Eligibility or program requirements Must prove job retention or job creation out of proceeds.A personal guarantee for any owner with 20% or more stake in the business. A personal guarantee for any owner with 20% or more stake in the business.May require the borrower to pledge primary residence if there is more than 20% equity in their home.

Things to consider with an SBA 504 loan

The SBA 504 loan can be a great loan program for eligible business owners or aspiring real estate investors looking to purchase and finance a new qualifying business or existing real estate. But keep in mind that while an SBA loan offers competitive rates, it's a tedious and lengthy process that can take anywhere from 40 to 60 days to finalize. It's suggested applicants should seek alternative financing first, like a conventional loan, before applying for the SBA 504 loan program -- especially if they're tight on time. It's also important to note that there are considerable fees associated with an SBA loan, which currently through Sep. 30, 2020, are as follows:

  • Guarantee fee of 0.5% upfront.
  • Servicing fee of 0.3205% (32.05 basis points) of the outstanding balance of the loan, which is charged annually.
  • Processing fee of 1.5%, which includes the processing of the loan and legal review.
  • Funding fee, which varies based on the loan type and amount.

While these fees can be rolled into the financing, it's generally a higher-cost loan than a conventional loan program regarding fees.

If you think you would benefit from an SBA 504 loan, speak with a qualified mortgage broker or banker at an SBA-approved lending institution. Only certain banks have the ability to fund an SBA loan, so it's important to find a banker or broker who is experienced with SBA loans and can help you navigate the application and funding process.

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