SBA FAQ: What are SBA Loans and How Do They Work?

how do sba loans work

Key Takeaways

  • The Small Business Administration (SBA) created SBA loans to help make it easier for small businesses to secure bank-rate financing.
  • Before applying for an SBA loan, be sure to identify your business needs. Are you planning to branch out? Do you need money for equipment purchases? Knowing why you need a loan allows you to zero in on the best type of SBA loan for you, streamlining the application process.
  • Keep in mind that SBA loan applications may take a month or more to underwrite. If you need immediate funding, SBA loans may not be the right loan for you.

Businesses of every size will most likely need outside financing at some point in their lifespan. If you’re a veteran business owner, chances are you know that SBA loans are among the best financing options out there.

The federal government partially guarantees SBA loans. The Small Business Administration (SBA) works with participating lenders, who then grant small business applicants with the funding needed to operate their business.

If you’re considering applying for an SBA loan, this article is a great place to start. In it, we discuss what SBA loans are, the various types of SBA business loans available to you, how they work, as well as the benefits and drawbacks when applying for them. Let’s dive in.

What are SBA Loans?

SBA Loans are business loans backed by the federal government, which participating lenders issue. The Small Business Administration (SBA) can guarantee anywhere from 50% to 95% of the total loan amount (typically around 80%). This means if the business (the borrowing party) goes under or is unable to repay its loan for any reason, the federal government will shoulder that agreed upon percentage of the loan.

Lenders, especially banks, are notoriously known to be risk-averse. Most often they are reluctant to lend to small businesses as they see them as risky borrowers. However, the government guarantee that’s built into an SBA loan offers ample assurance and lessens the risk the lenders are taking on by lending to small businesses. In turn, the lenders can provide flexible payment terms to small business owners.

What are the Different Types of SBA Loans?

1. 7(a) Loans

2. CDC/504 Loans

3. Microloans

4. Disaster Loans

5. Community Advantage Loans

6. Export Loans

7. CAPLines

There are a number of different SBA loan programs each tailored to different small business needs. It’s imperative that you identify what your business needs are before you begin the application process. Do you need additional working capital to grow your inventory? Are you planning to open another location? In order to choose the right solution, you must first identify the problem you’re aiming to solve.

Here’s a breakdown of the seven most common types of SBA loans:

1. 7(a) Loans

Interest Rates: 5% to 10%
Repayment Period: 10 to 25 years
Collateral: Not for loans less than $25,000

The 7(a) loan is the most popular SBA loan type that small businesses apply for. Eligible businesses qualify for a minimum of $300,000 to a maximum of $5 million in funding, and they can use the loan’s proceeds to cover business expenses like:

Start-up costs

Equipment repairs or purchases

Land acquisition

Expansion

Business acquisition

Debt refinancing

Inventory Purchase

Buying supplies

The repayment period for the SBA 7(a) will generally depend on the purpose of the loan. If the proceeds are used to boost working capital or buy equipment and supplies, the loan repayment period will not exceed ten years. However, for real estate, borrowers can repay the loan over 25 years. The rates will also depend on the business performance and will fall between 5% to 10%.

2. CDC/504 Loans

Interest Rates: 2.612% to 2.933%
Repayment Period: 10 to 25 years
Collateral: No additional collateral required (aside from the building or equipment being financed)

If your primary goal for seeking funding is to fund long-term investments such as real estate and equipment, the CDC/504 loan could be a viable choice. In partnership with the Certified Development Companies (CDC) and private lenders, the SBA can provide up to $5 million ($5.5 million for energy and manufacturing businesses) of funding to small businesses through the SBA CDC/504 loan program.

Some of the uses of the SBA CDC/504 loans include:

Acquisition and development of lands

Improvement of existing buildings

Buying heavy equipment or machinery

Refinancing debt (only if the debt’s proceeds are used towards the improvement of business facilities or buying equipment)

The SBA has imposed restrictions on how you can use this type of loan. Businesses cannot use the loan proceeds towards the following purposes:

Acquisition and development of lands

Debt consolidation on existing long-term debts for working capital and other purposes outside facility development or equipment acquisition

Inventory purchases

Working capital boost

In order to receive this type of loan, the business (applicant) must comply with these rules pertaining to the use of the loan, and must also create or retain one job for every $65,000 (or $100,000 for small manufacturers) of funding received through the loan program.

The SBA 504 loan program can have a repayment period of 10 to 25 years, depending on the purpose. Equipment purchases can have a repayment period of 10 years, while loans obtained to acquire or develop real estate properties can have a repayment period of 25 years.

3. Microloans

Interest Rates: 8% to 13%
Repayment Period: Six years or less
Collateral: Yes

As its name implies, an SBA Microloan provides smaller financing amounts to business owners. If approved, businesses can receive anywhere from $500 to $50,000 in funding. Since it’s a much smaller amount than other types of SBA loans, the repayment period will also be shorter, usually less than six years, and the interest rates are usually higher (between 8% to 13%).

The SBA specifically tailored microloans to help underserved communities gain access to additional working capital. With the funding, business owners can purchase inventory, supplies, equipment, and meet day-to-day expenses. Unlike other SBA loans, microloans are usually obtained through non-profit community lenders.

4. Disaster Loans

Interest Rates: 4% to 8%
Repayment Period: Up to 30 years
Collateral: Yes, for loan amounts greater than $25,000

Businesses located in places where a calamity has recently occurred may be eligible for low-cost financing through the SBA Disaster Loan program. This financing is specifically designed to help small enterprises recover their losses from a declared disaster.

When applying for this type of loan, the lenders will assess the extent of the damage caused to the business to determine the loan amount they can offer. Once approved, eligible businesses can receive up to $2 million in funding. In some cases, companies can be approved for a loan amount 20% greater than the total cost of damages, if the proceeds are going towards the protection of the property in the event of another similar disaster.

Some of the uses of the SBA Disaster loan include:

Repairing physical damages

Replacing or repairing broken equipment

Covering operating expenses after a disaster

Paying for bills the business could otherwise afford if a disaster had not happened (i.e., rent, utilities, loan repayments, etc.)

Covering payroll

Purchasing additional inventory

The interest rates for SBA disaster loans are still lower compared to conventional loans. For businesses that cannot obtain credit elsewhere, the interest rates will start at 4%. However, for companies who are eligible for credit elsewhere, the interest rates will start at 8%. The repayment period for Disaster Loans can extend up to 30 years, depending on the business’ performance and loan amount.

5. Community Advantage Loans

Interest Rates: 7% to 9%
Repayment Period: Seven to 10 years
Collateral: Yes

The Community Advantage Loan is a pilot program the SBA launched in 2011. The pilot programs operate for a limited period of time and this one in particular is available to small business owners until September 2022.

The main goal of this loan program is to provide a source of funding for businesses in underserved markets that wish to expand their operations. Underserved markets refers to businesses owned by women, veterans, minorities, and companies that are considered high-risk, such as start-ups.

Both established and start-up companies can apply for the Community Advantage Loan. If approved, they can receive between $20,000 and $250,000 in funding, which can put towards start-up costs, purchasing additional inventory, buying equipment, acquiring other assets, and other business costs.

6. Export Loans

Interest Rates: 6.75% to 11%, depending on the Export Loan Program
Repayment Period: 12 months to 25 years, depending on the Export Loan program and use of the proceeds
Collateral: Not needed for loans issued as lines of credit; required for financing greater than $25,000 structured as a term loan

The SBA Export Loan is another SBA financing option tailored to support the needs of companies participating in export activities. If you’re already exporting your products or are planning to enter the export market, this could be a viable loan option to help you get the working capital you need.

With the SBA Export Loan Program, businesses can get a maximum loan amount of $5 million. The maximum guarantee the SBA can provide is 90% (approximately $4.5 million), depending on the business performance and loan amount. These loans can be structured as a term loan or line of credit.

SBA Export Loans have three programs: the Export Working Capital Program, the Export Express Program, and the International Trade Program. Here’s a brief description of each:

Export Working Capital Program (EWCP): This loan program encourages export activity by allowing businesses to apply for a cash advance for their purchase orders and receivables. With the EWCP, companies can get up to $5 million in funding to use for financing supplies, inventory, and the manufacturing of their goods.

Export Express: Eligible businesses applying for Export Express loans can get up to $500,000 in funding. The proceeds can fund export development activities like market research, acquisition of properties and assets, or refinancing existing export loans. Among the three types of SBA Export Loans, the Export Express is the most straightforward and flexible loan option.

International Trade Loan (ITL): International Trade Loans are viable options for businesses producing goods in the U.S. with plans of exporting the products to other countries or those who have been severely impacted by imports in the recent years. The goal is to provide these businesses with the means to compete.

Under the loan program, up to $5 million is available for small businesses. The extra capital boost can be put towards buying, building, or remodeling facilities involved in exporting goods.

7. CAPLines

Interest Rates: 7.25% to 9.75%
Repayment Period: 5 years for Builder’s CAPLine; up to 10 years for other CAPLine Loan Programs
Collateral: Yes

If your business is looking for a line of credit rather than a term loan-structured business financing, the SBA CAPLines might be the most suitable choice for you. The SBA CAPLine is simply an SBA-backed line of credit meant to meet a business’ short-term needs. This could be recurring operating costs, covering seasonal cash flow gaps, or any unforeseen expenses.

With a line of credit, you can withdraw any amount, repay it, then re-access the funds if needed. This feature makes it a perfect choice for companies that need a constant injection of cash into their business (i.e., those that sell inventory or need financing to fund large projects regularly). With a line of credit, you’ll only have to pay for the amount you use, plus interest.

In general, there are four types of CAPLines:

Working Capital CAPLine is solely for working capital needs. The business cannot use it to cover business taxes.

Seasonal CAPLine funds are for businesses that need extensive inventories to meet customer demands during the business’ peak season or to offset high receivables (usually for service-based industries).

Contract CAPLine funds are specifically for contractors that need to finance the general and administrative costs of contracts. The SBA doesn’t allow the funds to go towards acquiring assets, refinancing debts, or paying taxes.

Builder’s CAPLine funds are helpful for contractors looking to finance the construction and renovation of residential or commercial properties. The loan proceeds can be put towards supplies, fixtures, labor, landscaping, utility, and other expenses related to building construction or remodeling.

All but Builder’s CAPLines have a maturity period of 10 years. Builder’s CAPLines, by regulation, have a repayment period not exceeding five years.

How do SBA Loans Work?

One of the most important things to emphasize regarding SBA loans is that the Small Business Administration (SBA) doesn’t provide the loan to business owners per se. They work with accredited lenders who are actually the ones that underwrite the loan to the small businesses.

So, how do SBA loans work? The perspective borrower (business owner) applies through the bank or any other SBA-accredited lender. You’ll have to submit a plethora of documentation as required by both the lender and the SBA. This usually includes personal and business financial and credit reports, the business’ registration, credit reports, tax returns, resumes, authorization for credit, and more. The lenders may also ask for additional documentation like business plans, a business lease, or articles of organization, so be sure to have that as well.

Some of the SBA loans may require the borrowers to present collateral to secure the loan. The most common collateral used includes:

Real estate

Heavy equipment

Inventory

Accounts Receivable

Buildings

Lenders may also require the business to sign a personal guarantee agreement for all SBA loan programs. A personal guarantee is a person’s legal promise to repay the loan balance using their personal savings or assets if the company fails to pay it. The personal guarantee and collateral mitigate the risk the lenders and SBA face when lending large amounts to small businesses.

To assess your eligibility for the loan, the lender typically looks at five aspects, namely:

Ability to repay the loan

Business history

Equity invested in the company

Debt-to-income ratio

Collateral offered

If the lenders approve your application, you’ll then move to closing. You can expect to sign a lot of documents at this stage, such as security documentation, promise to pay, insurance forms, and more. This step involves a lot of back and forth and may take approximately three weeks to complete.

If the lenders approve your application, you’ll then move to closing. You can expect to sign a lot of documents at this stage, such as security documentation, promise to pay, insurance forms, and more. This step involves a lot of back and forth and may take approximately three weeks to complete.

That said, if you’re looking for a quick loan to fund time-sensitive business initiatives, SBA loans might not be the best choice for you right now.

SBA Loan Advantages

You might be wondering why SBA loans are among the best loans for small businesses? If you’re still on the fence about it, here are some of the benefits they offer:

1. Low-interest rates

Loans offered by the SBA are among the most affordable in the market. Since the federal government backs the loan up, lenders can offer flexible terms, including a low-interest rate. Also, the SBA usually caps off the maximum interest rate lenders can charge for the loan.

The different types of SBA loans have varying interest rates. Disaster loans offer the lowest interest rates, which usually hover around 4% to 8%, depending on whether you’re eligible for credit elsewhere or not. Still, for other types of SBA business loans, the interest rates offered may be lower compared to any conventional bank loans.

2. Longer repayment period

SBA loans typically have a repayment period of 25 years. Again, this is dependent on the type of loan and use of the proceeds. The extended maturity period of SBA loans allows you to spread the payments out, so you won’t have to worry about coming up with a large repayment each month. That also means you’ll have more cash to spare to cover other business needs.

Currently, the maximum SBA loan maturities are:

25 years for real estate use

10 years for equipment use

10 years for working capital use

3. There’s an SBA loan type for every business need

Whatever your business needs at the moment are, you can be sure there is a type of SBA loan to help you fund it.

For instance, if you want additional working capital to expand your business operations, you can apply for an SBA 7(a) loan. Or perhaps your business incurred physical damages brought about by a declared disaster, and you need help recovering. In this case, the SBA disaster loans would make a viable choice.

SBA Loan Disadvantages

It’s important that we provide you with all the necessary information about SBA loans to help you make informed decisions. That means noting the disadvantages you may face in the application process. These include the following:

1. You Need Collateral

Almost all types of SBA loans require you to present a form of collateral. This could be in the form of commercial real estate property (i.e., your warehouse, office building, store, etc.), heavy equipment, or machinery. This assures the banks that they will be able to take your asset and sell it for cash in the event your business becomes unable to meet the required repayments.

While the lenders generally don’t turn your loan application down due to insufficient collateral, it does affect your eligibility and loan terms. This can make the loan application process even more challenging for small start-up businesses.

2. Requires a High Personal and Business Credit Score

Your credit score is a testament to your behavior as a borrower. It’s usually one of the first things that lenders look at when evaluating your eligibility for the loan. Usually, the lenders will look at both your personal and business credit score. If both credit scores are high, this will increase your chances of approval. On the contrary, if either of your credit scores is low, it can negatively impact your eligibility for an SBA loan.

3. Approval can be as long as 90 days

One of the things that usually causes discouragement among applicants is the lengthy application process for SBA loans. In most cases, the earliest that the borrowers get approved for the loan is 30 days after submitting the application, given that they were able to provide all the documents the lenders and SBA require. The longest waiting time for approval is 90 days.

4. The business must be at least two years old

Lenders and the SBA will want to know your repayment behaviors and whether you’ll be able to afford the loan repayments, especially if you’re applying for a higher loan amount. This means you will have to submit years-worth of financial documents, including balance sheets, bank accounts, credit reports, etc.

As per the SBA rules, the business must be at least two years old to qualify for an SBA loan. That could be a problem if you’re one of 400,000+ new businesses looking for funding each year.

Bottom Line: Are SBA Loans a Right Fit for my Company?

There’s no one-size-fits-all when it comes to small business loans. The choice of whether SBA loans are suitable for your business or not depends on your company’s needs and qualifications.

In general, SBA loans may be the right fit for you if you meet the eligibility criteria that both the SBA and lenders require. It’s also worth noting that the purpose of the loan may also be considered as the SBA is especially strict when it comes to where the borrowers spend the proceeds of their loan. When applying, you should be clear on where you’ll use the proceeds and explain how the funding or project being funded will contribute to the business’ overall success.

Moreover, SBA loans are usually considered last-resort financing for small businesses. Before they can qualify, the business might have to take the “Credit Elsewhere Test” which, according to the SBA, “determines whether the borrower can obtain some or all of the requested loan funds from alternative sources without causing undue hardship.”

That said, if you have an excellent financial and credit background and you’re looking to apply for a higher loan amount at an affordable rate, SBA loans might just be the best resource for your business.

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