What is an SBA 504 loan and how does it work?

SBA 504 loans are long-term, fixed-rate loans for small businesses offered by the U.S. Small Business Administration (SBA). The SBA 504 program supports small business growth and job creation. These loans are financed by certified development companies (CDCs) and third-party lenders and guaranteed by the SBA. They usually require the borrower to have at least 10% equity.

SBA 504 loans have a number of requirements and rules about how borrowers can use the funds. Like all financing, SBA 504 loans include fees, interest, and specific repayment terms.

How SBA 504 Loans Work

SBA 504 loans are a financial solution for small business owners who want to purchase real estate or equipment. These loans can be a good option for small business owners who don’t qualify for conventional financing.

The U.S. Small Business Administration (SBA) supports loans but does not provide funds. CDCs, which are nonprofit economic development organizations, work with SBA-approved banks and credit unions to provide financing.

CDC will provide 40% of the financing, and an SBA-approved bank or credit union will provide 50%. Borrowers are responsible for a 10% down payment.

Key Features of an SBA 504 Loan

SBA 504 loans have certain features that determine how much you can borrow, how much the loan will cost, and how you can use the funds.

Maximum amount

Some eligible energy efficiency or manufacturing projects may qualify for up to $5.5 million in funding. In most cases, the maximum SBA 504 loan amount is $5 million.

Minimum credit rating

The SBA does not list minimum credit score requirements for borrowers. SBA lenders may have their own credit score requirements.

Advance payment

Borrowers typically make a 10% down payment on SBA 504 loans.

Fees

The fee is typically 2% to 3% of the 504 portion of the loan. Borrowers may have to pay a processing fee, a guaranty fee, a financing corporation fee, and a bond broker fee. Fees may be included in the loan amount and therefore financed.

Interest

SBA 504 loan rates are fixed rate loans. Interest rates on loans are set incrementally above the market rate on 10-year U.S. Treasury notes.

Terms

SBA 504 loans are offered with terms of 10, 20, or 25 years.

Usage

Small business owners can use SBA 504 loans for a variety of purposes. You can:

• Buy existing buildings or land
• Buy long-term machinery and equipment
• Build new objects
• Improve land, streets, utilities, parking, landscaping and existing facilities.

Time for financing

It could potentially take you months to get through the application period and processing to receive your funds. SBA loans typically take longer to process than private loans because they have requirements from both lenders and the SBA.

SBA 504 Loan Qualification Requirements

To qualify for an SBA 504 loan, you must meet several eligibility criteria.

SBA Requirements

• You must run a commercial company.
• You will have to do business in the United States.
• You need a feasible business plan and relevant management experience.
• You may have no other sources of funding available.
• Your net worth must be less than $15 million.
• You must meet SBA size standards, which vary by industry.
• Your average net income must be less than $5 million after taxes for the previous two years.
• You may not engage in activities such as property rental speculation, loan processing, gambling, multi-selling or illegal activities.
• You must be able to demonstrate the ability to repay the loan using the projected operating cash flow from your business.
• You must demonstrate good character, which is determined by a history of paying debts and obeying the law.

Lender’s requirements

Lenders require borrowers to meet all SBA eligibility criteria. SBA lenders may also have their own criteria, such as minimum credit scores or income requirements, that they use to evaluate potential borrowers.

Project requirements

Borrowers can use SBA 504 loans to purchase or construct buildings, land, new facilities, and machinery and equipment. They can also use the loan to improve existing facilities. They cannot use the funds for working capital, debt consolidation, or rental property investments.

How SBA 504 Loans Compare to Other SBA Loans

The SBA also offers 7(a) loans and microloans. Let’s take a closer look at how both of these types of loans compare to 504 loans.

SBA 504 Loan vs. SBA 7(a) Loan

The 7(a) Loan Program, the SBA’s main business lending program, offers several different types of loans. Small businesses can receive a maximum of $5 million under this program. SBA 7(a) loans can be used for working capital; acquisition of refinance or improvement of real estate and buildings; business debt refinancing; acquisition of machinery, equipment, furniture, fixtures and consumables; change of owners; or several goals. Borrowers are not required to provide collateral for loans of $50,000 or less.

SBA 504 Loan vs. SBA Microloan

SBA microloans offer small businesses financing of $50,000 or less. Small businesses can use these loans for working capital, equipment, machinery, fixtures, furniture, supplies and inventory.

How to Apply for an SBA 504 Loan

You will need to find a CDC to apply for an SBA 504 loan. The SBA offers a resource that allows you to search for local CDCs. CDC and the borrower will complete an application, which the SBA will use to determine the applicant’s eligibility for the loan. You will need to provide personal information and information about your business.

Repaying an SBA 504 Loan

You will repay your SBA loan with monthly payments determined by the total loan amount, interest rate, and terms. Payments can be made via Automated Clearing House (ACH), wire transfer or check.

You can ask CDC any questions you have about payment.

Bottom line

SBA 504 loans may be an affordable financing option for eligible small business owners. Borrowers can compare the features, fees, interest and terms of an SBA 504 loan with other financing options to decide which is best for their small business.