How Do 504 Loans Work?

by Mike Price | Published on May 18, 2022

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SBA 504 loans can lower your real estate loan costs and increase the loan term, but are they right for you? Learn the benefits of applying for an SBA 504 loan.

It's a badge of pride to qualify for a real estate loan from your bank. It means the bank picked you up by your ankles, held you upside down to shake out all your lunch money, and you still survived.

Sometimes, it’s better to hide your pride and look into real estate loan programs that are meant for lower-performing businesses. Let’s talk about the 504 program.

Overview: What is an SBA 504 loan?

The SBA (Small Business Administration) 504 loan program was set up to encourage banks to lend to borrowers they otherwise wouldn’t. It does this by reducing the loan-to-value (LTV) of the bank’s loan. In a typical situation, the bank lends 50% of the collateral value and a Certified Development Company (CDC) makes a loan (called a debenture) for up to 40%. The borrower then covers the remainder of project costs.

This means the typical 504 loan has a 90% LTV. Including other costs and variance between appraised value and purchase price, the borrower will likely need to inject a little more than 10% of project costs.

The CDC can place its loan in the second collateral position (meaning it's paid out by a foreclosed collateral sale after the first position lender is made whole) because its loan is guaranteed by the SBA.

Most banks are used to 75%-80% LTV on real estate loans so a 50% LTV is often enough to push the credit to approval even if there are underwriting issues.

There are a variety of uses for 504 loans, but since they're typically structured based on collateral value, they're almost always used to purchase or improve real estate.

3 benefits of the SBA 504 loan program

You’ll notice no benefits mention that down-on-their-luck companies can get a loan they otherwise wouldn’t have qualified for. SBA 504 loan eligibility is a little easier than SBA 7(a) eligibility, especially if the business is minority-owned. Many strong businesses apply for an SBA 504 to get better loan terms.

In each section, we’ll compare the typical 504 loan term to a conventional term -- conventional meaning the loan you'd get by walking into a bank branch and talking to the banker.

1. Longer loan term

Most conventional real estate purchase loans have a 5-year or 10-year term with a balloon at the end. The bank will calculate your monthly payment based on a 20-year or 25-year term, and then whatever is left over when the 10-year term is up comes due in one big lump-sum payment.

The 504 first loan (the loan from the conventional lender) term will be up to 25 years and the debenture term will be 20 years. Some CDCs are offering 25-year terms.

2. Lower interest rate

Conventional real estate loans are often tied to the Wall St. Journal Prime rate (WSJ Prime Rate) and are fixed for the first five or so years of the loan. A typical rate would be something like prime + 2.5%, fixed for five years. That means after five years, the rate would adjust to whatever the current prime rate is, plus the 2.5% spread.

The 504 first loan will probably have the same rate as the conventional lender offers on any other real estate loan. Debenture rates are the killer. The CDC I worked with in Utah is Mountain West Small Business Finance. It’s currently offering a 2.54% rate on a 25-year term. You won't see 504 loan rates for commercial real estate.

When you combine the payments on the two loans, it will be considerably lower than what it would’ve been for the same loan amount conventionally. This also works to help businesses with lower cash flow and cash qualify for the loan. You can debt service for a higher monthly SBA payment, and you don’t have to inject as much cash.

3. Lower equity injection

Bank credit risk managers get very nervous if you go over 75% LTV. That LTV is based on the appraised value of the property, not the project costs. So if you offer $500,000 for a building, and it only appraised for $475,000, the bank won’t lend more than $356,250 ($475,000 x 75%). You have to come up with the difference between the loan amount and the purchase price, plus all closing costs.

If you use the 504 program, you can go up to 90% LTV, allowing you to conserve your cash for other uses.

Who is eligible for an SBA 504 loan?

To qualify for a 504 loan, your business must have a shareholder’s equity balance under $15 million and average net income from the last two years of less than $5 million.

There are other CDC-specific SBA requirements. For example, you can’t use the 504 program for a passive business, i.e., real estate rental. Talk to your local CDC about the requirements. Some of them can be worked around: if you have a minority- or woman-owned business or if you add energy savings items to your project.

How to apply for an SBA 504 loan

Here’s how to get a 504 loan for your business.

1. Reach out to your banker or CDC

The first step is to talk to your normal business banker about a 504 loan. If your bank doesn’t specialize in SBA loans, it may make sense to check out a big bank to see if they know more.

Also, be wary of bankers who immediately try to talk you out of doing a 504 loan. For many bankers, 504 loans can produce as little as 20% of the commission of 7(a) loans. If your banker doesn’t know much about the program or poo-poos it, consider contacting a local CDC.

2. Go through underwriting

Underwriting is the annoying part. Be prepared to be put through the wringer and provide the following items:

  • Three years of tax returns
  • Interim financials
  • Business plan
  • Real estate purchase contract
  • Management resume
  • Personal financial statement
  • Entity or organization docs

The bank will also pull your personal credit, order an appraisal, and potentially order a LexisNexis report on your business.

One more thing: because you will technically have two loans, you have to go through underwriting twice. The bank and the CDC need to approve your loan. A good CDC will be working concurrently with the bank to get their own underwriting done far ahead of time.

3. Close conventional loan and bridge note

The CDC has to jump through many government hoops, so it won’t be able to close with the first loan. Your bank should close the first loan along with a short-term bridge loan, with interest-only payments, that will be paid off by the debenture when it closes.

4. Complete CDC approval

This is where the CDC will go through the SBA process on its end to guarantee the debenture. For a good CDC, this should take three months max.

If your project includes construction, the CDC will not pay off the bridge loan until the project is complete. Most banks will do a bridge loan for the full amount during the construction period.

5. Close CDC loan and pay off bridge loan

The final step is closing the CDC loan and paying off the conventional bridge note. Once this is done, you can start making your two monthly payments.


  • There are pros and cons to each, and as we mentioned before, you may not be able to trust your banker to be completely clear with you.

    The 504 program will take a lot more work since you’re getting two loans approved. But there is the opportunity to get a much lower fixed rate with a 504 loan.

  • You will make one payment to your conventional lender and one to the CDC. Both will send you monthly statements.

  • Debentures can go up to $5.5 million if the project includes all kinds of fun energy savings items, such as solar panels. This implies a total collateral value of $13.75 million ($5.5 million / 40%). However, I have seen 504 projects with total costs north of $25 million.

    This is because though the debenture can’t go above $5.5 million, the conventional lender can go over 50% LTV. If the conventional lender goes up to 70% LTV, and the borrower brings in 11% of project costs, the total costs could theoretically be $28 million.

Don’t abhor 504

As you’ve probably realized, getting a 504 loan doesn’t exactly mean the bank (and CDC) won’t pick you up by your ankles and hold you upside down to try to shake you, it’s just that you’ll be able to keep more of the lunch money.

These 504 loans make sense for a lot of businesses, but they’re no walk in the park to complete. Keep all your options open the next time you buy a building.

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