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  • Writer's pictureRic Armstrong

How SBA Loans Work

SBA loans are issued by private lenders, which are typically, but not always, banks. The key difference between an SBA loan and other business financing is the government guarantee. The government backs the loan, meaning that it agrees to pay the lender a portion of the balance if the borrower defaults.

Because of this, the SBA limits how much interest lenders can charge on SBA loans and requires extended repayment periods, bringing down long-term costs. What’s more, lenders often use less stringent credit requirements when underwriting SBA loans than they would for a traditional small business loan even though the agency doesn’t set specific credit score targets.

A potential downside, however, is that many SBA loan applications require two approvals—one from the lender and one from the SBA—which can slow down funding. The exception is if you’re borrowing from a preferred lender, or PLP. These lenders have the authority to approve and commit to loans without sending them to the SBA’s general processing center.

Once an SBA loan closes, the lender is responsible for releasing the money to the borrower on an agreed-upon schedule. For ongoing expenses, such as construction or shipping materials from abroad, you’ll likely receive deposits in phases, not as an upfront lump sum.

Types of SBA loans

The most common type of SBA loan is a 7(a) loan. Small-business owners can seek 7(a) loans to provide up to $5 million in funding for:

  • Working capital, like paying employees

  • Purchasing equipment, furniture and supplies

  • Purchasing, constructing or remodeling real estate

  • Refinancing existing debt

  • Assisting in business acquisition or expansion efforts

There are also SBA Express loans, a type of 7(a) loan that the SBA estimates it can review in 36 hours (compared with the five to 10-day review window for standard 7(a) loans). Express loans can be up to $500,000, but the SBA only guarantees 50%.

Another option is a 504 loan, which is more specific than a 7(a) loan, Katz says, and is used mainly for major equipment purchases and buying or improving real estate. The maximum loan amount is also $5 million, but certain energy projects may qualify for more.

Microloans of up to $50,000 are also available through SBA’s nonprofit partners. They can be used for many of the same purposes as the larger loans, except for paying existing debt or buying real estate. They may be a good option for independent contractors and other business owners who work alone and have low revenue or no collateral to offer.

The only loans that the SBA issues itself are disaster loans. These provide business owners with funds for repairing physical structures and covering operating expenses if they’ve been impacted by a federally-declared disaster, such as a hurricane.

How to qualify for an SBA loan

SBA loans are available to for-profit businesses that operate in the U.S. or its territories. An exception is businesses that deal in speculative activities or lending, such as a bank, casino, real-estate investment firm or multilevel marketing company.

Depending on your industry, company size will be measured by annual receipts or number of employees. A winery, for example, can have up to 1,000 employees before it is no longer considered a small business. A florist must have annual receipts—that’s gross income plus the cost of goods sold—of $9 million or less.

Lenders also look at whether the business owner has exhausted other avenues for funding. The SBA wants to see that borrowers have no other affordable financing options available, including personal assets. In general, SBA is considered to be kind of the lender of last resort.

Startups are often well-positioned for SBA loans since many traditional banks won’t take a chance on lending to a brand-new business. Make sure you have a business plan and are prepared to prove that you’ve invested some of your own time and money. Individual lenders decide on factors like credit score minimums, business cash flow requirements and whether collateral is needed.

SBA loan rates and repayment terms

Interest rates on SBA loans are negotiated between the lender and the borrower, within the SBA’s minimums and maximums.

The lowest rate lenders can charge is the prime rate, which is what banks charge their most creditworthy customers (the prime rate is influenced by the federal-funds rate, or the overnight lending rate between banks).

The highest interest rate lenders can charge depends on the type of loan and amount, whether the rate is fixed or floating and the repayment term. For a standard 7(a) loan of $51,000 or more, the interest rate can’t be higher than the prime rate plus 3%. (Keep in mind, the majority of 7(a) loans have floating rates, meaning the rate can change multiple times a year along with the prime rate.)

It is possible to find conventional small business loans with slightly lower rates, particularly for borrowers with great credit and a strong business. The big difference is SBA loans tend to have much more favorable terms.

For example, a bank may require a 20% to 30% down payment for a conventional small business loan for commercial real estate, whereas SBA lenders often require just 10% down.

Repayment terms for an SBA loan are also more generous. If you obtain a loan for equipment, working capital or inventory, you get 10 years to repay it in monthly installments, compared with the typical two- to five-year repayment period for a non-SBA loan.

SBA loans used for real estate typically have a 25-year repayment period. Many conventional loans have smaller, interest-only payments in the beginning and a larger so-called balloon payment when the loan term ends in 10 or 15 years. With SBA loans, all payments are fully amortized, meaning that each payment is made up of principal and interest.

Source: Wall Street Journal


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