Apart from the many values small businesses contribute to an economy, the jobs they create add up to the development of a community. But these small businesses often face many challenges that might affect their growth due to the lack of business capital.
Through the Small Business Administration, the U.S. government makes available loan programs these businesses could take advantage of to support several projects.
Through the SBA, the loan is extended from preferred financial institutions or credit unions to the borrowers. Because small businesses have a diverse need for funding, the SBA has provided different loan programs for different purposes.
These loan programs often have terms the borrowers will have to keep up with. One of such loan programs that the SBA offers is the SBA 504 loan.
Here, let’s explore all you need to know about the SBA 504 loan.
What is the SBA 504 Loan Program?
This is one of the loan programs the U.S. government provides through the SBA (Small Business Administration) to small or medium-sized businesses.
In collaboration with Certified Development Companies (CDC), the SBA makes this loan available to promote business in communities. In doing this, they get to accept a relatively low down payment on this loan.
The SBA 504 loan offers a long-term repayment period between 10-20 years to businesses into commercial real estate or heavy machinery projects. The loan funds could amount to up to $5.5million.
A little brief about the CDC: A Certified Development Company is a nonprofit corporation approved and managed by the SBA. Its primary aim is to help develop its community by working with lenders to make funds available to small businesses. This is because they are aware of the community’s needs and challenges.
Structure of the SBA 504 Loan
In this program, three parties are responsible for covering the loan financing. The lender covers 50%, CDC covers 40%, and the borrower will cover 10%. But if the borrower defaults on the loan payment, the lender is paid first to reduce the risk on the lender’s side.
For businesses that are new in operation below 2years, their equity will be 15%, making it a structure of 50%, 35%, 15%. Also, suppose you’re running a new business together alongside a property for special purposes. In that case, your equity will be 20%, creating a structure of 50%, 30%, 20%.
Who Qualifies For This Loan?
If you’re a business owner, several factors will make your business qualify for this loan. These factors include:
- Your business should be above the early planning stage.
- Your business operations or possessions must be in the U.S.
- Your business should be running with an average net income of $5 million two years before the loan application and a net worth of less than $15 million.
- The business must meet the general SBA loan requirements and occupy 51% of the building space to run its operations.
What Can The Loan be Used For
This loan program is offered to small businesses for the specific purposes of developing the local community. Other purposes include:
- Purchase of equipment or machinery with a 10-year life span.
- Building new facilities or renovation of a building.
- Clearing up debts incurred from purchasing equipment.
- Improving the land.
- Land surveying and appraisal.
- Purchasing commercial real estate properties.
Terms and Interest Rates
The maturity terms depend on the particular loan you obtain. They’re available for 10years, 20years, and 25years, respectively. The interest rate for a 10year loan period will be 4.85%, and that of 20years will be 5.07%
Added to the terms of this loan, borrowers are eligible for 3months of loan forgiveness. However, the SBA will not give a fixed payment period for your loan, as they’ll be making your loan payments. Instead, you can relate with the CDC to agree on your repayment plan.
How Do You Get an SBA 504 Loan?
You’ll need to look out for a CDC that will help you with the application process. This nonprofit organization will organize your financing and present the loan package to the SBA for approval.
Moreover, you will need several documents to apply for this loan. The documents include:
- Your business plan.
- Three years of tax returns for your business.
- Your own tax returns for three years.
- Your financial and business financial statements for the last three years. Also, the building contractor estimates and cost documentation will be required.
The financial institution you work with and the CDC might request additional documents to be presented. Note that the SBA loan might take between 1-2 months to close when your application is approved.
Five Myths About SBA 504 Loan
There are a lot of myths that are said about this loan program – popular beliefs that aren’t true. Most of these myths come from borrowers who might have gone through the process with financial institutions that are not regularly involved in SBA 504 loans.
Below are prevalent myths about the SBA 504 loan.
1. The business property must be 100% owned by the business: Business owners often think that they must have 100% occupancy of the property in use. Meanwhile, the SBA loans require only a 51% occupancy requirement.
2. The SBA is the moneylender: You must know that the federal government is not responsible for lending these funds through the SBA. If not, the borrower will pay tax returns on their purchase property.
3. The loan procurement period is too long: Borrowers tend to have this mindset towards SBA loans because they require several documents from the borrowers. Meanwhile, the lender works with all the parties involved to ensure the loan is efficient and closes quickly.
4. It is only for startups or small family-owned businesses: The loan goes beyond mom & pops or small businesses. In the actual sense, many businesses can take advantage of this loan program. These could include middle or large-sized companies with a good number of employees.
5. It’s the last loan option for a business owner: With the low-interest rate, and long-term repayment period, business owners shouldn’t see the SBA 504 loan as a last resort.
Four Major Benefits of SBA 504 Loan
The SBA 504 loan comes with a lot of benefits for small businesses. Some of these advantages include:
1. 90% Loan Financing:
Unlike the 7(a) loan the SBA offers that gives 85-90%, the 504 loan provides 90% of the total cost of a project to small businesses.
2. The majority of Small Businesses in the U.S. will Qualify:
The application process won’t be challenging to navigate because of the resources and tips the SBA makes available. Another advantage for small businesses is that the SBA guarantees a part of the loan.
3. Loan Interest Rates are Affordable:
This loan program offers a fixed interest rate, and it’s of great benefit to the borrower. That’s to say, if the business owner has a repayment period of 10-20years, the interest rate will remain the same.
4. This Program Offers Low Down Payments:
A regular loan program will charge between 25-40% for a down payment, but the 504 loan offers a 10% down payment. Because of its affordable nature, business owners will want to go for this loan program.
Five Drawbacks of this loan program
The SBA 504 loan could be an excellent option for small businesses because of its benefit to borrowers. But apart from the benefits, you should look into the drawbacks of this loan before making your funding decision.
1. Restricted Usage:
This program does not permit borrowers to use the funds obtained as their business working capital. Instead, it can only be used specifically for restricted business purchases given by the SBA.
2. The Application Process involves too many parties:
This program requires three parties, the borrower, the lender, and the CDC (Certified Development Company). Here the borrower doesn’t just work with the lender. Instead, it’s of utmost importance that the CDC and the lender agree on the terms of the loan and the SBA requirements.
3. The Applicant Will Cover a Percentage of The Loan:
As much as it could be seen as an advantage, this can also be a disadvantage to the borrower. Its upside is that the loan will cover 90% of the amount for the project, and the business owner involved will cover just 10%. But depending on the project’s overall cost, the 10% could be excessively high for the borrower.
4. The Business Must Create Job:
As a business, one qualifying guideline is that for every $65.000 they receive through the SBA, they must ensure to maintain an existing job or create a job. If the business cannot create a job, the business will have to meet a public goal.
5. Slow Timing:
Unlike the home mortgage loan that takes just 30days to close, the SBA real estate loan will take about 60 to 75 days. However, this loan might be slow for a business owner.
The SBA 504 loan presents small businesses with finances to purchase, refinance a property or construct commercial properties. In turn, these projects could also provide job opportunities in the community.
If you’re a business owner looking for a loan to support your business with the purposes listed above, you can utilize this advantage.