An Entrepreneur’s Ultimate Guide to SBA 504 Loans

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Table of Contents

    Key Takeaways

    • The SBA 504 Loan is designed primarily to help small businesses invest in real estate properties or purchase equipment. With one, companies can get up to $5 million (or more) in funding, depending on the purpose of the loan.
    • SBA 504 loans can have a repayment period of 25 years, depending on where the proceeds went. For real estate investments, the repayment period could be as long as 20 to 25 years, while equipment purchases have 10 years repayment period. If the proceeds were used towards real estate and equipment, the repayment period could be as long as 25 years.
    • To qualify for an SBA loan, you must have a good or excellent credit score, strong business revenue, stable cash flow, and your business must be operating for at least 2 years.

    SBA loans are among the most common and affordable small business financing options available for business owners. Since they are guaranteed by the federal government, banks and other lending institutions tend to offer better loan terms, such as an extended repayment period and low-interest rates. Government-backed loans can be harder to qualify for, but if you are approved, you could receive millions in funding for your small business.

    The Small Business Administration offers a variety of loan programs designed to meet specific needs of small business owners. In this article, we’ll be focusing on the SBA 504 Loan program.

    Ready to apply for an SBA 504 Loan?

    What is an SBA 504 Loan?

    The SBA 504 Loan is a program designed to provide small business owners with financing needed for the purchase of fixed assets – i.e. the acquisition or improvement of real estate and buildings, or the replacement of heavy equipment or machinery. Through this program, applicants can receive up to $5 million (or $5.5 million for certain businesses).

    The SBA 504 loan structure is more complex than that of most other SBA loans. It involves three key players, namely:

    1. The business or borrowing company

    2. The Certified Development Company (CDC), which is anon-profit organization whose focus is to help the economic development of struggling communities

    3. Intermediary lenders (SBA-approved affiliates)

    The Small Business Administration (SBA), CDC, and affiliate lenders grant this type of funding to small businesses to encourage job creation and economic development in communities.

    How It Works

    Here’s a breakdown of the funding structure:

    ➥ The third-party lender will fund 50% of the loan amount
    ⇨ 40% will come from the SBA-approved CDC
    ⇨ 10% will serve as the down payment for the loan, which the business owners will shoulder

    The lenders and CDC may require a larger deposit from the businesses, especially if their financial and credit history isn’t strong. Moreover, small businesses still in the early stages of operation will have to present a larger down payment to mitigate the risk both the CDC and the lenders are facing.

    As for the SBA’s role, it serves as the guarantor for the loan. This means that in the event of a default, the SBA would have to repay a portion of the loan balance – usually somewhere between 50% and 80% of the total loan amount.

    It’s worth noting that applicants can only qualify for an SBA loan if he or she is unable to qualify for a conventional loan elsewhere.

    SBA 504 Loan Uses

    The affordability of an SBA 504 loan is what makes it an attractive financing option for many small businesses. Eligible businesses can get up to $5 million in funding, depending on the business’s credentials. However, you’ll only be able to use the loan for asset acquisition and improvements.

    With the funding, you can cover business expenses like:

    • Buying a new building for business-use
    • Opening warehouses
    • Expanding or renovating existing business facilities
    • Purchasing new equipment
    • Improving streets, utilities, parking spaces, or landscaping
    • Refinancing debt (if the purpose for taking out a debt was to construct new buildings or buy/replace equipment)

    An SBA 504 loan cannot be used for:

    • Working capital boost
    • Debt consolidation of existing long-term debts not related to acquisition of properties or equipment purchases
    • Investing in rental real estate
    • Buying additional inventory
    • Payments for accounts receivables

    If your business is looking to fund any of those listed as ineligible uses for the SBA 504 loan, this type of loan is not the best funding option for you.

    Furthermore, the SBA imposed additional rules for the eligible uses of the CDC/504 loans. For instance, if you’re using the loan to acquire or develop an existing building, the SBA requires the owners to occupy at least 51% of the space and rent out the rest. For the construction of new buildings, the SBA will require them to occupy at least 60% of the building in the first few years and increase the occupancy to 80% on or before the tenth year.

    For equipment purchases, the SBA only allows the acquisition of machinery and equipment with an expected lifespan of at least ten years. Things like computers or photocopy machines would not qualify as they typically don’t last that long.

    Before applying for the SBA 504 loan program, ensure that the project you’re planning on funding will coincide with the guidelines the SBA has set. Not only will this increase your chances of approval, but it will also expedite the loan approval process.

    Ready to apply for an SBA 504 Loan?

    What are the SBA 504 Loan Terms

    Once you qualify for an SBA 504 loan, the bank will determine the loan terms based on your business’s performance. Here’s how they usually set the terms:

    Loan Amount

    Loan amounts for the SBA CDC/504 loans can range from $25,000 to $5 million. The SBA and CDC might also be willing to extend the loan amount to $5.5 million for green businesses and manufacturing companies.

    The amount you will be eligible for will depends on several factors. The lenders may assess your credit rating, business income, purpose for the loan, and industry before deciding on the exact loan amount.

    Again, you (the borrower) will have to cover the down payment for the loan – typically 10%. Larger down payments may be required for start-up companies, or if you’ll be using the funding for special purpose properties. The SBA defines special purpose properties as “a limited market property with a unique physical design, special construction materials, or a layout that restricts its utility to the specific use for which it was built.” A special-purpose property could be an amusement park, farms, gas stations, swimming pools, and more.

    Interest Rates

    In general, SBA loans offer much lower rates than those of a conventional bank loan since they’re backed up by the federal government. This makes it the most viable funding option to consider if you’re planning to acquire, build, or improve properties and equipment.

    With SBA 504 loans, the borrowers can expect to pay two different rates: that of the CDC and another rate for the lender’s portion of the loan.

    The SBA will decide on a fixed rate for the CDC portion of the loan. It’s usually calculated based on the U.S. Treasury Bonds– which is fixed U.S. government debt securities with a maturation rate of 20 years – plus a spread of investor returns. The CDC rate for the loan usually falls between 3% and 6% of the financing.

    On the other hand, the lenders can set an independent rate for their portion of the loan which will depend on the borrower’s financial and credit history. In general, the rates on the lender’s portion of the loan don’t usually exceed 10% and it can either be fixed or variable.

    Fees and Penalties

    It’s also worth noting that the figures discussed above may not include the fees that the SBA, CDC, and lenders charge for the loan. In most cases, the SBA, CDC, and financing companies will charge the fees separately. The CDC fees are subject to the SBA’s approval, while the lenders may decide on the fees themselves as they see fit.

    Here are the fees you can expect for a typical SBA 504 loan:

    • Guarantee fees (SBA) – The SBA charges a guarantee fee of 0.5% of the total loan amount, which the borrowers will have to pay upfront.
    • Annual SBA fixed rate fee – On top of the guarantee fees, the SBA will also charge an additional 0.3205% annual fee on the loan’s unpaid principal.
    • Servicing fee (CDC) – The CDC may also charge a servicing fee of 0.625% to no more than 2% of the total loan amount. The borrowers are required to pay this fee every year.
    • Late payment penalties (CDC) – Fees paid any time after the 15th of the month (deadline for monthly payments) are subject to a 5% fee or $100 on top of the regular repayment amount. The CSA collects these fees on behalf of the CDC.
    • Central service agent fee – The CSA may also charge an ongoing fee of no more than 0.1%. The fee is paid together with the monthly repayments for the SBA 504 loan.
    • Lender participation fees – Lenders may charge the borrowers a 0.5% fee paid one time upon underwriting.

    The banks may also charge miscellaneous fees like underwriting, processing, funding, and closing fees. As you shop for lenders, be sure to ask each one what fees they charge and how much they are as this usually varies from one lender to the next.

    If the borrowers decide to prepay the entire loan amount, the lenders may charge a prepayment penalty fee depending on which year they choose to pay the loan off in full. If the borrower decides to prepay the loan within the first year, they could be charged a 3% prepayment penalty fee. The percentage drops with each consecutive year until it reaches 0% by the 11th year.

    Repayment Period

    Along with low-interest rates, SBA loans also offer longer repayment periods, which typically runs from ten to 25 years, depending on the purpose of the financing.

    If the purpose of the loan is to purchase fixtures, machinery, and equipment, the financing can have a maximum repayment term of ten years. SBA 504 loans used forreal estate acquisitions can have a repayment period of 20 years. If the business owners are planning to use the loan proceeds towards real estate and equipment, the loan repayment term could go up to 25 years.

    All payments for SBA 504 loans are to be fulfilled monthly. The SBA and lenders will set a fixed loan amount (plus ongoing fees) which you’ll be required to pay every month before the 15th day.

    Ready to apply for an SBA 504 Loan?

    Pros and Cons of the SBA 504 Loans

    Pros

    There are many other SBA financing options available out there, but here are five reasons why the SBA 504 loan in particular may be the best option for your business.

    1. Larger Loan Amounts

    Borrowers eligible for the SBA 504 loan can get as much as 90% – 40% from the CDC and 50% from the third-party lenders – in funding for their projects. Other conventional loans will only offer as much as 60% to 75%, and even SBA 7(a) loans max at 85% of funding.

    Once approved, borrowers can get up to $5 million in funding, which is an ideal amount for financing long-term and high-value projects like buying and developing land or acquiring other forms of assets (i.e., equipment).

    2. Extended Repayment Period

    Again, the repayment term for SBA 504 loans can extend up to 25 years, depending on the loan’s purpose. This long repayment period allows you to spread your repayments over a long period, so you won’t have to worry about coming up with a large sum every month or at the end of the loan’s term (balloon payment).

    3. Affordable Rates

    While the SBA 504 loan rates will vary based on the current economic conditions at the moment of application, once it’s decided, the rate will remain fixed throughout the loan period. In other words, the monthly repayment amounts will stay the same until the end of the term.

    4. Lower down payments

    Compared to other types of loans (i.e., SBA 7(a)), the down payment requirements for the SBA CDC/504 loans are among the lowest in the market. If you have an excellent financial and credit background, the SBA and lenders may only need a 10% down payment. The down payment for SBA 504 loans can be significantly lower than the SBA 7(a) loans which require up to 15% down payment, or conventional bank loans which require as much as 25% to 40%. That said, for business owners looking for an affordable form of financing, SBA 504 loans might be an excellent choice.

    However, it should be noted that if the SBA and lenders find discrepancies in your financial or credit report, or if you have a fair (less than 620) credit score, they might require you to cover a higher percentage of the financing.

    5. Almost all businesses can apply for one

    If you’re wondering if your business can qualify for a 504 loan, then you’ll be glad to know that almost all small businesses in the United States can qualify for one as long as they meet the requirements the SBA has set.

    You may have to demonstrate to the lenders that you’re beyond the planning stages of your project. What does this mean? Simply put, you must be in a situation where you’re ready to execute on whatever project you need the loan for – be it the construction of a building or a big equipment or real estate purchase. For example, if you need the loan to purchase equipment, you should have a quote from the dealer before you apply for the loan. In some cases, you may be required to present your business plan.

    Cons

    The benefits to 504 loans are certainly intriguing, but it’s also important to note the drawbacks so you (the borrower) can make an informed decision. Here are five worth pointing out:

    1. The financed property or equipment will serve as collateral

    SBA 504 loans don’t require additional collateral when applying, but they do tie the loan’s financing up with the property or equipment that’s acquired using the loan’s proceeds. This provides the SBA and lenders with assurance that they will be able to recoup any losses in case of a default.

    2. You may have to sign a personal guarantee agreement

    On top of pledging the financed property or equipment as collateral, both lenders and the SBA may also require borrowers to sign a personal guarantee. A personal guarantee is the borrower’s legal promise wherein the business owner takes responsibility for the loan repayments using his or her personal assets or resources if the business becomes unable to do so.

    Some business owners maybe uncomfortable with this arrangement as it means putting their personal assets on the line.

    3. Limited loan uses

    Unlike a business line of credit or a term loan, SBA 504 loans are specific to real estate or any fixed-asset acquisition. This means that the use of the loan’s proceeds will only be limited to purchasing commercial buildings, construction of a new facility, parking spots, street improvements, landscaping, or purchasing equipment and machinery. The SBA emphasizes that SBA 504 loans must not be used to boost working capital or refinance existing long-term debts.

    4. Lengthy application process

    Since there are multiple parties involved – the federal government being one of them – the loan application could take weeks to months to complete. The due diligence alone can take as long as 30 days or more if you fail to submit some of the required documents. After that, the CDC and lenders will have to coordinate and discuss the terms (which must be in compliance with the SBA regulations) to offer you.

    In general, the entire application process of SBA loans may take a few weeks or up to 60 days at most. If you’re looking for fast or instant access to cash, the SBA 504 loan might not be the most suitable choice for you.

    5. Must be used to create or retain jobs

    In addition to the SBA’s primary requirements for the 504 loans, business owners must also make sure they create or retain one job for every $65,000 provided by the SBA. If the project cannot meet the requirement, they must do at least one community development or public policy goal. As per the SBA, these are some of the public policy goals:

    • Business district revitalization
    • Expansion of exports
    • Expansion of minority business development
    • Rural development
    • Increasing productivity and competitiveness
    • Restructuring because of federally mandated standards or policies
    • Changes necessitated by federal budget cutbacks
    • Expansion of small businesses owned and managed by veterans (especially disabled veterans) and women.

    Ready to apply for an SBA 504 Loan?

    SBA 504 Loan Requirements

    Since the federal government backs it, qualifying for the SBA 504 loan may not be a walk in the park. In fact, it’s one of the most challenging loans to qualify for.

    To become eligible for an SBA 504 loan, you must first meet the general guidelines the Small Business Administration has set for all their loan programs. This includes:

    • Must be operating for profit
    • Have reasonable equity invested in the business
    • Must be operating within the United States or any U.S. territories
    • Meeting the SBA’s definition of a small business (i.e., must have fewer than 1,500 employees, maximum annual receipts not exceeding $38.5 million, etc.)
    • Stellar financial and credit background (a score of 650 or higher
    • No prior history of defaults, especially on government loans
    • Inability to obtain credit elsewhere

    You may have better chances of approval if your business has a low debt-to-income ratio and no history of bankruptcies, as this usually raises a red flag to lenders, the CDC, and SBA.

    In addition to the general criteria for SBA loans, here are the criteria specific to SBA 504 loans:

    • Project to be funded must encourage job openings and improvement of the community’s economy
    • Meet the loan program’s building occupancy requirements
    • Have a tangible net worth of no more than $15 million and average net income of $5 million after taxes for two consecutive years prior to the date of loan application

    Since the SBA CDC/504 loan program aims to improve the community’s economy through job creation, it’s vital that you are able to prove to the lenders how you’ll go about meeting that requirement. Again, this is where your business plan would come in handy.

    Ready to apply for an SBA 504 Loan?

    How to Apply for an SBA 504 Loan?

    Now that you have a general overview of SBA 504 loans and their rates, repayment periods, loan amounts, and uses, you might be wondering how you can apply for the financing. If you’ve already decided on what project to finance using the SBA 504 loan and have a realistic number of how much you need to borrow, here are the next steps you need to take:

    1. Double-check your eligibility

    The SBA 504 loans are among the best and most affordable financial resources available for small businesses. However, with that benefit comes a competitive application process. To increase your odds of qualifying for the loan, lenders will want to see a solid financial report and good credit history. The financing companies will want to know that you can afford the repayments and that you’re less likely to default on the financing

    As discussed above, you need to meet the SBA’s general requirements on all their loan programs. On top of that, you’ll also have to meet the SBA 504-specific requirements (i.e., must create other jobs, occupancy requirements, etc.). You’ll also want to consider the minimum requirements third-party lenders may impose.

    The lender’s requirements for SBA 504 Loans could include, but are not limited to the following:

    • Must have annual revenue of at least $100,000
    • A personal credit score of at least 620 or higher
    • At least two years of business history

    2. Prepare all the documents

    Be sure that you have all your documents ready for submission, as this will help expedite the process.

    Here’s what the SBA and lenders will expect you to submit during the loan application process:

    • Profit and loss statements
    • Balance sheets
    • Personal and business bank statements
    • Personal background statement
    • Professional resume
    • Personal and business credit report and score
    • Personal and business tax returns
    • Legal documents (business licenses, articles of incorporation, franchise agreements, etc.)
    • Business plan
    • Purpose of the loan
    • Debt schedule
    • Collateral

    Some lenders may require you to submit additional documents like business leases, a quote from the dealer, and more. Be sure to ask lenders about what other documents they might require so you can prepare them before hand and submit upon request.

    3. Find a CDC

    Since it’s a CDC/504 loan, you’ll also have to find an SBA-certified CDC partner within your community to provide up to 40% of your financing. The CDC will double-check your eligibility and evaluate your documents to make sure you will use the loan towards an approved purpose.

    If you’ve already found a lender to work with, they might be able to help you out when finding a CDC. You can also use the SBA’s CDC finder to help you find a CDC in your area.

    Once you find one, submit your application, then wait for it to get approved.

    4. Find a lender

    Once you’ve verified your eligibility and received the CDC’s approval, the next step is to find an SBA-certified lender. The SBA works with hundreds of intermediary lenders, usually banks, so finding one within your community shouldn’t be a challenge.

    Most of the banks and non-profit lenders now offer online applications for potential borrowers. All you have to do is visit their website and prequalify. The prequalification process may or may not incur a hard inquiry on your credit, so be sure to check that before going about your application.

    The terms that the CDC and SBA offer will be pretty consistent, regardless of where you apply. However, before moving forward with your application, you might want to check the terms the lender has imposed on the loan, as the SBA does allow them to set their own rules in the financing arrangement. Pay extra attention to the interest rates and fees. The more quotes you can get from different lenders, the better. Compare them and choose the best one that you think will suit your company’s needs and budget.

    You’ll also want to pick a lender that has ample experience with SBA loans as they will know the ins and outs of the SBA financing process and can help you navigate through it smoothly. Usually, there are “preferred” SBA lenders. If you see this badge on the financing company’s website, it indicates that they process a substantial amount of SBA applications at any given time.

    5. Submit your application to the lenders

    Once you have the approval from all parties, it’s time to submit your application to the lenders. The lender, in turn, will process your application and send it to the SBA. The CDC may also file your application with the SBA, but this redundancy could be necessary for securing a loan.

    You have choices when it comes to applying. You can either apply in person or do it online. If you choose to apply in person, it might take a few hours to complete, and the lender might require you to submit additional documents. Again, asking what other requirements they may ask for beforehand will help. Applying online usually only takes a few minutes, but you may be required to make a personal appearance for verification purposes.

    Once you’ve finished the application process, all that’s left to do is wait for approval. SBA loans usually have a turnaround time of 30 to 60 days.

    When the SBA approves your loan, go over the contract’s fine print before signing. Review the rates, fees, and repayment period granted to you. Be sure that these figures coincide with your business’s needs and budget.

    The Bottom Line: Is an SBA 504 Loan Right for Your Business?

    Whether you need additional funds for working capital, acquiring properties or equipment, or rebuilding after a disaster, there’s an SBA loan that will suit every need. SBA 504 loans are affordable financial resources that let you invest in specific business initiatives like real estate, equipment, machinery, and fixtures. So long as you meet the eligibility criteria set by the government, you’ll be able to take advantage of the more significant loan amounts, low-interest rates, and extended repayment period that SBA 504 loans offer.

    If you’re a start-up company, you may want to consider other loan options to build up your credit background before diving into the lengthy process of SBA 504 loans. This will lessen your chances of SBA Loan denial. Older, more established companies with an excellent financial and credit track record will have a better chance of qualifying for the loan.

    Finally, be sure to do your homework. The more you know, the better informed you’ll be when deciding whether the 504 loans will fit your company’s funding needs or not.

    Pros
    Lower monthly paymentsHigher funding amountRates are highly competitiveTax benefits
    Cons
    Long and tedious applicationLenders usually accept creditworthy borrowersCollateral may be required

    Pros

    Lower monthly payments. The longer repayment period of long-term loans also translates to more affordable monthly payments since payments are spread out over a long time. Business owners won’t have to worry about straining their monthly cash flow at the end of each month when they’re paying back the debt.

    Higher funding amount. Long-term loans come with higher loan amounts – usually up to $5 million. If the bank grants you the financing, you can put the funds towards large investments like expanding your business to another location, adding more staff, product expansions, or buying new equipment.

    Rates are highly competitive. Banks usually offer the best rates when it comes to long-term loans. However, they are notorious for being strict when it comes to small business loan applications. Nevertheless, you can still get a better rate for long-term loans than other types of financing when you apply for a long-term loan from alternative lenders.

    Tax benefits. The interest rate you pay on your loan is tax-deductible, given that you meet the eligibility criteria for the tax break. For one, you and the lender should have a true lender-debtor relationship, meaning your lender should not be a member of your family or one of your friends; And two, you have to actually spend the loan’s proceeds.

    Cons

    As attractive as long-term business financing may seem to those looking for an affordable source of funding, it’s worth noting that it also comes with its set of downsides. Here are the cons of long-term business loans:

    The application can be long and tedious. If you do decide to pursue long-term loans, you’ll have to be prepared to go through a good amount of red tape, paper work, and multiple assessments (especially if you’re applying for an SBA loan). The higher the loan amount is that you’re applying for, the more rigorous the approval process will be. So if you’re looking for quick access to cash to address a time-sensitive investment, this might not be the best financing option for you.

    Lenders might require borrowers to be established and creditworthy Remember, long-term loans involve large sums. That said, lenders will want to work with established borrowers who are a couple of years old and have generated substantial revenues in the past few years. The business must also have a good credit score (650 or higher) and have no history of loan defaults to improve their odds of qualifying.

    You’ll have to pledge collateral. Whether it’s a car, your home, expensive business equipment, or inventory, the bank will require you to present some sort of collateral for the loan. This provides security to the lenders and incentivizes them to offer better loan terms. If you default, you could risk losing a valuable item.

    Where and How to Apply for a Long-Term Loan?

    One thing you should know about long-term loan applications is that the application process will vary from one lender to the next. Each will have a varying set of eligibility criteria and steps to take.

    When it comes down to it, banks usually offer the best terms. However, their processes are also the slowest and most manual. Sometimes the entire loan application process can take 30 to 90 days. While there are banks that offer online applications, most of the time you’ll need physically visit the bank to submit the requirements and meet for your interview, among other assessments.

    Online lenders and other Fintech companies have a more expedited application process. They don’t require as much documentation as banks do, and they allow borrowers to complete their entire application online, submitting only electronic copies of their financial documents and other paperwork. That said, the expedited process typically comes with higher interest rates.

    Requirements for a Long-Term Loan Application:

    Regardless of the lender you choose to work with, being prepared always expedites the process. In general, banks and other lenders will ask you to submit the following requirements:

    • Government-issued valid IDs
    • Business licenses and permits
    • Balance sheets
    • At least two years’ worth of personal and business financial statements
    • At least two years’ worth of personal and business tax returns
    • Business plan
    • Collateral documentations
    • Debt schedule
    • Use of proceeds statement

    Always be truthful and honest on your paperwork and documentation. If the bank or lender sees inconsistencies, it will only drag the application process out further and may even lead to a loan rejection. Sometimes the lenders will ask for additional documents to further verify your eligibility. This can include business lease documents, articles of incorporation, manager resumés, and others. Coordinate with your chosen lender’s loan manager to discuss what additional documents they might require so you can prepare them beforehand.

    Ready to apply for an SBA 504 Loan?

    Wrapping Up

    While business financing can aid a lot of opportunities for growth, it does comes with risks and drawbacks that may compromise your company’s financial stability. Be sure to do your research and consider these before applying for long-term loans, or any business loans for that matter.

    At the end of the day, if you’re looking for a financing option to help you address a large investment – i.e. renovations, building construction, product expansion, or equipment purchases – long-term loans can be a viable financing solution. You can apply for one from banks or alternative lenders. Banks tend to offer the best terms, but alternative lenders will be less strict and more flexible regarding the qualifications.