SBA Collateral Discount Rates

Discount rates determine what percent of collateral your bank will lend. Read on to learn how to get different rates — and if you should.

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Owning and running a business requires a lot of specialized local knowledge. You have to know which employees don’t get along and shouldn’t work together. How to find good articles about SBA loans. How to get the best deal on inventory. What the best prices for all your products are.

One of the things you don’t have to know is what SBA collateral discount rates are, or why they matter. It could still be worth your time to study them. Read on to find out.

Overview: What is the discount rate?

The discount rate is applied to collateral that you purchase with a loan. The SBA prefers loans over $350,000 to be fully secured. That means, if the discounted value of the collateral is less than the total loan amount, the bank will need to seek additional collateral. That could be a second lien on your residence or the titles to vehicles that you wholly own.

You can find the various SBA discount rates in the SBA SOP (Standard Operating Procedures). Here are the current discount rates for the SBA’s main 7(a) product:

A table showing each collateral type’s current rate.

The SBA heavily discounts ARs and inventory which it calls trading assets.

Why do different types of collateral have different discount rates?

There are several factors that go into the SBA’s discount rates including age of the collateral, ease of resale, and how well the collateral maintains value.

Each factor makes intuitive sense. You would want to discount used equipment more than new because it’s hard to know exactly how much wear and tear there is on used equipment. Likewise, you would discount inventory more than real estate, because many types of inventory quickly spoil or go out of style.

How the discount rate affects your loan

Let’s take a look at a few different SBA loan examples and see how the discount factor would affect each.

1. Purchasing real estate

When I underwrote SBA loans, the vast majority were done to get better discount rates or loan terms than the borrower could achieve with a conventional loan.

A conventional real estate loan typically has a 10-year term with a 25-year amortization. This means you make payments as if the loan was due in 25 years and then owe a big balloon payment after ten years. This kind of loan discounts collateral by 25%-30% depending on the borrower's credit strength. You can shop around, but that’s about as good as it gets.

If you use an SBA 7(a) loan, the lower appraisal value or sale price will be discounted by 15%. This means you have to come up with the 15%, either through additional collateral or, more likely, cash. That is far better than the conventional 25%-30%. On a $1 million loan, it could be an extra $150,000 that stays in your bank account.

The other option is to go with an SBA 504 loan. The 504 product works differently than the 7(a) product. With a 7(a) loan, the bank lends you the money, and the government guarantees 75%. With a 504 loan, you actually have two loans: one from a conventional bank and one from a not-for-profit entity that is guaranteed by the government. The conventional note takes first position on the collateral, which means if you default, the normal bank gets paid first.

SBA 504 loans will lend up to 90% of the collateral value if your business has good credit.

2. Equipment

You may have noticed on the table above, there are three different ways to discount equipment values. Brand new equipment is discounted by 25%, and used equipment is discounted depending on how it’s valued. If you take the net book value (cost - depreciation) off the balance sheet, it has a 50% discount. If you get an orderly liquidation value (OLV) from an appraisal, you only have to discount it by 20%. These appraisals cost anywhere from $250 to $3,000, depending on the type of equipment and number of items.

New equipment is discounted by 25% because the resale value will never be the same as the sticker price. Orderly liquidation value, on the other hand, is the price that a professional appraiser thinks you could quickly sell the equipment for, so it is discounted less. That doesn’t mean you should order an appraisal on new equipment to get a better discount rate — the OLV is probably substantially lower than the new price.

In my experience, OLV is used when a borrower is stretching to make a loan work and needs to eke out a few more dollars from existing equipment value. Otherwise, we go with half of the book value and save the money on the appraisal.

Conventional lending will have similar rates. Some big banks have specialized departments that work with different equipment types, and you may have better options there. Many times, the best option is to work with a leasing company. You start with far less down, but the lender makes it up in higher payments.

3. Working capital and trading assets

Loans secured by trading assets (accounts receivable and inventory) are typically for working capital. The SBA discounts the value of trading assets by 90% when used as a collateral add-on for other loan types.

ARs are notoriously unreliable at holding value. Most businesses don’t have a great sales contract, and most customers are incredibly hard to contact for collections.

Inventory can be even worse. A bank I worked for once got stuck with hundreds of niche medical devices with no way to sell them. At one point, we resorted to listing them on eBay for a fraction of their supposed collateral value.

The SBA prides itself on being a self-sufficient organization. It claims it can support the guarantees that it pays out to banks with the guarantee fee it charges for each loan. Part of being able to do that is having a lot of collateral coverage with reliable collateral.

The only way to escape the 90% discount to trading assets with an SBA loan is with an SBA express loan or one of the SBA line of credit products.

SBA express loans are only 50% guaranteed and prompt the lender to use its own underwriting standards. You should only apply for an SBA express loan if you truly can’t obtain conventional financing. Conventional financing is likely cheaper.

Likewise, the SBA line of credit products are not meant to be evergreen products. They exist to be used by startup businesses or businesses in a rough patch. If you can qualify for a conventional line of credit, it’s probably cheaper.

How do you weigh the discount rate?

You need to consider many factors when seeking financing. What’s your plan with the loan funds? What’s the loan term? What’s the interest rate? What’s the collateral discount rate? It all comes down to money.

If you can secure a lower down payment with an SBA loan, but at the expense of higher fees and a higher interest rate, you need to think hard about whether it’s worth it. If you are growing fast and those payments can easily be made a few years from now, but right now you need the cash, it makes sense. If you’re awash with cash but want a lower payment, go with the other option.

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