A Quick Guide to SBA Loans
First off, SBA stands for the Small Business Administration. The SBA is a U.S. government organization that seeks to stimulate economic growth by providing loans to small businesses. The SBA doesn’t actually lend money directly to businesses, it “backs up” the loans from banks – meaning it acts as a guarantor so the business receiving the loan gets lower interest rates. This “back up” makes SBA loans incredibly cost-effective, and frankly, the cheapest option out there for business funding.
Is there a Catch to SBA Loans?
That’s the thing – there’s really no monetary, long-term downside to getting an SBA loan, other than the fact you have to pay it back. The interest rates are very low for SBA loans compared to most loans, and the payback terms are favorable – up to 25 years for an SBA 7(a) loan.
The only drawback is how long it takes to get an SBA loan. SBA loans are easier to qualify for than traditional bank loans, but regardless, you’re still working with a bank. Even with the government guaranteeing a portion of SBA loans, the process is still slow and tedious – banks review credit, financial statements, legal documents, business plans, and often even expect collateral.
Also, unfortunately for those without stellar credit, borrowing history is important to the banks giving out SBA loans. A great credit score is what makes your loan application stand out, along with being well-established. SBA 7(a) and CDC/504 loans are often exclusively given to non-startups, and you have to have a pretty good track record of repayment. SBA microloans, however, are often given to startups, albeit they’re significantly smaller in amount.
Types of SBA Loans
SBA loans come in three kinds: 7(a), CDC/504 and microloans. They vary mainly in size and purpose.
SBA 7(a) Loans
An SBA 7(a) loan is the most popular SBA loan program, and it’s good for up to $5 million. It works for most general needs, and repayment terms can be up to 25 years. With it, you can purchase just about anything you need, but it’s usually used for larger investments. Some options are:
- Purchasing new land
- Generating working capital
- Repairing existing capital
- Purchasing or expanding an existing business
- Refinancing debt
- Buying industrial equipment or other large purchases
To qualify for a 7(a) loan, there are specific requirements:
- Your business is for-profit
- You’ve been in business for a pretty significant amount of time, although there are no specific time requirements.
- You have to meet the SBA definition of “small business,” which varies by industry. The specifications and requirements can be found via the SBA in this PDF.
- You are located and operate in the U.S.
- As a business founder, you’ve invested your own money (and time) in the business.
On top of these requirements, there are certain factors that SBA loan lenders will look for in a company’s application.
- You have to have good credit. There’s no minimum, but it’s usually expected that your credit score is 650 or above.
- Collateral is also not required, but it’s a valuable asset to have. If you have collateral to use as security, it can make you stand out more to lenders.
- It’s usually expected of you to be making revenue. Lenders want you to be able to pay back a loan, and that usually equates to you being profitable (around $100,000 a year or more).
- Your debt service coverage ratio (DSCR) compares your incoming cash flow and debt obligations, and it’s expressed as a decimal. The SBA usually requires that this be at least 1.15.
- You should have a solid business plan for the next three to five years. It should express your financial projections, competition and market understanding.
Types of 7(a) loans
To make things more complicated, there are several different types of SBA 7(a) loans
- A standard 7(a) loan can go up to $5 million and will be approved or denied within about five to 10 days. Collateral isn’t required if the loan is under $25,000, but over $25,000 requires that banks follow the same policies they use for non-SBA loans.
- A 7(a) small loan functions the same way, but is only for amounts up to $350,000 and it prescreens the applicant’s personal credit, business credit, and business finances. If you pass, your application jumps the line. If you don’t pass, you go through a more strict underwriting process.
- An express loan is also for up to $350,000 but offers a quicker turnaround. Usually, this means the SBA will notify you of initial approval within 36 hours. However, the SBA only guarantees up to 50%.
- An export express loan has a 36-hour turnaround as well, but it is for up to $500,000 and is guaranteed for up to 90% by the SBA.
- An export working capital loan can be for up to $5 million, but specifically for businesses that produce export sales. You’ll hear back in around five to 10 days, and it’s guaranteed for up to 90% by the SBA. It does, however, require that the SBA take export-related inventory as collateral, as well as all receivables from export sales.
- International trade loans are for businesses that compete internationally for businesses. They have the same rules as export working capital loans.
- CAPLines of credit are lines of credit offered by the SBA. They go up to $5 million, last for five to 10 years, and are intended for all different business types. The SBA will guarantee up to 85%, and as with all the 7(a) loans, interest rates are negotiated by lenders and borrowers, but will never exceed the SBA maximum (which varies based on the Prime rate and market trends but is usually relatively low).
What does a 7 (a) loan cost?
- The question everyone wants an answer to. Like every loan, the interest rate will vary based on your business’s financial health, but overall, SBA 7(a) loans are relatively low-cost. Remember, SBA loan interest rates are based on the Prime rate, which fluctuates, so your formal interest rate will change depending on when you get the loan. In addition to the Prime rate, SBA loans have negotiable interest rates tacked on, but they set maximums for these rates. The maximum rates are as follows:
|Loan maturity under seven years|
<$25,000 = Prime + 4.25%
$25,000 – $50,000 = Prime + 3.25%
>$50,000 = Prime + 2.25%
|Loan maturity over seven years |
<$25,000 = Prime + 4.75%
$25,000 – $50,000 = Prime + 3.75%
>$50,000 = Prime + 2.75%
- 7(a) loans also come with fees. The highest of these is the guaranty fee, which the SBA charges for guaranteeing the loan from a bank. It’s technically charged to the lender, but the lender will pass that fee on to the borrower. They’re calculated based on the percentage of the loan that is guaranteed, not on the entire loan amount, so they’ll vary based on the type of loan and loan amount.
- Repayment terms for 7(a) loans depend on what you’re buying:
- Up to seven years for loans going toward working capital.
- Up to 10 years for loans going toward equipment purchases.
- Up to 25 years for loans going toward real estate.
The SBA CDC/504 is another SBA loan program, and it’s meant to purchase only fixed assets, like equipment and real estate. It cannot be used for working capital. It’s good for up to $5 million ($5.5 million for green energy companies), and the repayment terms are 10 years for non-real estate, and 20 years for real estate.
To qualify for a CDC/504 loan, you have to meet the same requirements as a 7 (a) loan, along with some more specific requirements on how the property is to be used.
- You must plan to use at least 51% of the property for its own operations within one year of it being owned.
- If you’re building from scratch, you have to use 60% all at once, and then plan to occupy 80%.
- The project has to create or retain jobs. This is the “current jobs requirement,” and says that your business must create or retain one job for every $65,000 of the loan, and 75% of the jobs must be within your own community. The purpose of this is to guarantee that you’re business will be contributing to sustained economic growth, and you’ll have to prove this with a very realistic estimation.
- OR, instead of promising to create jobs, you can try to prove that your company will satisfy another “public policy goal,” like aiding rural development or revitalizing a district.
CDC/504 loan specifics
It’s the process behind a CDC/504 that makes it so different. The loan is distributed by three parties – the bank, the Certified Development Company (CDC) and you, the business. You put down 10% of the loan (15% if it’s for “special uses,” which basically means the property is only be used for one purpose, like a gas station), the CDC provides 40%, and the bank provides 50%.
- What is the CDC, you might ask? CDCs are established under the 504 code as local, non-profit corporations that support economic growth in their localities. There are hundreds of them.
- The funds the CDCs provide are raised through monthly bond auctions 100% guaranteed by the government.
What do CDC/504 loans cost?
Interest rates for CDC/504 loan programs can get complicated. A portion is from the bank and a portion is from the CDCs. In short, the exact rate won’t be known until about 45 days after the loan is secured, but you can usually expect it to be between 5% and 6%.
- CDCs pool their projects and auction them to investors. This sale determines the interest rate, and the sale takes place about 45 days after you close the loan. Historically, it’s been around 4% to 5%, and after the bank rate, the total interest usually comes to between 5% and 6%.
- This complicated process, thankfully, is all handled automatically. Plus, the interest rate for CDC/504 loans are fixed, so once you get your rate based on all these factors, it’s the same for the life of the loan.
Fees are comprised of a guarantee fee, annual servicing fee, and a CDC fee. These are relatively small compared to interest rates and vary depending on the current rates set by the SBA.
The last SBA loan program is SBA microloans. Hence the name, microloans are smaller amounts but aren’t considered short term because as with the other SBA loans, they can be extended over a long period of time. They can be used for a range of things, including working capital, but are often used to start or expand new or startup businesses, which isn’t the case for the other two SBA loans. Microloans can be for up to $50,000, and allow for up to six years for repayment.
Also unlike the other two SBA loans, the microloan program loans money to intermediary, nonprofit lenders, and these lenders, in turn, provide loans to startups and small businesses. Most of the time these nonprofit lenders are specific to certain causes – such as expanding women-, minority- or veteran-run businesses.
The SBA doesn’t review microloan applications for creditworthiness, so that makes them a little easier to qualify for. There are other requirements, however:
- You must be a for-profit business.
- You don’t need good credit, but you need to be able to make up for it if you have bad credit. Things like collateral, a co-signer, or proving that your business makes a decent revenue.
- You have to submit a solid business plan that includes your financial projections for the next three to five years. You also should describe your background, history, target market, competitors and growth strategy.
- You will usually need collateral, and if your business doesn’t own anything yet, you’ll have to use your personal assets as collateral.
- You must demonstrate “good character,” which essentially means you’re not a flight risk and are responsible. Usually, you shouldn’t have a criminal record of crimes involving theft or fraud. It won’t disqualify you, but it will certainly make it harder.
How much do microloans cost?
- The SBA sets its own maximum interest rates that their intermediaries are allowed to charge. Depending on how much the intermediaries had to pay for the loan in the first place, the interest will usually be between 6.5% and 13%, but the average was around 7.6% in the 2018 fiscal year.
- The SBA doesn’t charge intermediaries fees for the loans, so they usually won’t charge fees to those they lend to. They are, however, allowed to charge up to 3% in packaging fees, and sometimes closing costs.
So How Do You Decide if SBA Loans Are Right For Your Business?
After looking at all the details of SBA 7(a) loans, CDC/504 loans and microloans, it’s pretty natural to be a little overwhelmed with all the information. As we warned – because you’re working with banks and the government, the details are plentiful and the paperwork is complicated. The point of FaaSfunds is to help you with all of this, and figure out if you qualify for an SBA loan, and which specific SBA loan is your best bet. We’ll help you figure out all the paperwork, and answer any and all questions pertaining to SBA loans. Give your business a helping hand, and make your financial world a little bit easier – sign up with FaaSfunds.