SBA 504 loans are different from conventional small business loans in many ways, and their terms have unique requirements and parameters. As such, here’s an explanation of the terms of SBA 504 loans.
Loan Amount
SBA 504 loans are available in amounts up to $12.5 million. This is because 504 loans are actually two loans – a Certified Development Company (CDC) loan and a third party lender loan – and the CDC loan is limited to $5,000,000. As the typical split for project funding with a 504 loan is 10% down payment, 40% CDC loan, and 50% third party lender loan, and $5,000,000 is 40% of $12,500,000, that makes $12.5 million the typical maximum loan size. However, as there’s technically no limit to the size of the third party lender loan, larger loan amounts can be doable in rare cases.
Down Payment
The minimum (and typical) down payment for SBA 504 loans is 10%. However, a higher down payment is required for a new business and/or limited/special purpose property, and a lender may require a higher down payment for any loan.
Interest Rate
SBA 504 loan interest rates are usually lower than other small business loan options, including conventional and SBA 7(a) loans. As a SBA 504 loan is in fact two loans – a CDC and third party lender loan, each with their own interest rate – the overall loan’s interest rate is somewhere in between the two, determined by the sizes of the loans. For example, if a 504 loan has the typical split of 10% down payment, 40% CDC loan, and 50% third party lender loan, the overall loan interest rate will be a bit closer to the third party lender loan’s rate, as it provides more of the overall loan value.
The CDC loan’s rate is low and predetermined, based on treasury bond rates (plus fees). The third party lender’s rate is higher and based on a benchmark rate, similar to an SBA 7(a) loan – but the rate is usually lower than that of a 7(a) loan due to the inherent stability and collateral of 504 loans. The overall loan rate being a combination of these means that SBA 504 loans often have an unbeatably low interest rate.
Finally, the CDC rate is fixed, while the third party lender’s rate is usually fixed, but can be either fixed or variable.
Term
SBA 504 loans have a maximum term of 25 years for loans involving real estate, and a maximum term of 10 years for equipment loans. These are also the typical terms, as a longer loan term means lower loan payments.
If a loan has multiple uses than include both real estate and equipment, the maximum (and typical) term is 30 years if >50% of the use of proceeds are for the real estate. If 50% or less is for the real estate, the loan will have a blended term (in between 10 and 30 years) determined by the proportion of the loan used for each purpose.
Collateral
SBA 504 loans are usually collateralized by the real estate involved in the loan, with further collateral rarely necessary.
Personal Guarantee
A personal guarantee for a small business loan means the borrower(s) will be personally financially responsible for the loan should the business not be able to make the loan payments. Most small business loans require a personal guarantee from the borrower(s), and this includes SBA 504 loans
For SBA 504 loans, all borrowers with a business ownership share above 20% are required to give personal guarantees. Additionally, anybody other than the owner (a manager, for example) with full control over the business is typically also required by the lender to give a personal guarantee.
Amortization
The amortization of a small business loan is the period over which the loan payments are spread. Most conventional loans are amortized over a period longer than the loan term, which makes loan payments lower, but necessitates a loan extension or balloon payment at the end of the loan term (as it’s still not fully paid off).
SBA 504 loans, on the other hand, are fully amortized, meaning their term and amortization period are the same. This means they’re fully paid off by regular, same-sized (other than the effects of interest rate changes) payments, with no balloon payment at the end. This is a notable advantage to 504 loans (and other government guaranteed loans, like SBA 7(a) and USDA B&I loans), as it makes the loan more secure and consistent for the borrower.
Prepayment Penalty
A prepayment penalty, included in most commercial loans, is an added cost for prepaying a loan before a certain time. There are a few different structures lenders use, but the most common one penalizes the borrower a certain percentage of the loan amount for prepaying the loan. Prepayment penalty periods are almost always shorter than the loan term, instead lasting a certain number of years before ending and allowing penalty-free repayments.
SBA 504 loans have long prepayment penalty periods, with the CDC loan’s being ten years and the third-party lender loan’s varying, like that of a conventional loan.
However, the two loans can be prepaid separately while maintaining the overall loan. Although borrowers rarely prepay the CDC loan before 10 years, it’s not uncommon for borrowers to prepay the third party lender loan before then.
Finally, all penalties must be paid when the real estate is sold. This means that regardless of the terms of the third party lender loan, the CDC loan’s prepayment penalty makes it more difficult to sell the property within 10 years.
