Though the SBA doesn’t loan directly to small business owners, they support financial institutions by guaranteeing a portion of loan — removing much of the lender’s risk. There are a number of lending programs available to small business owners meant to encourage people of all backgrounds and industries to embark on the American Dream.
What is an SBA loan?
An SBA loan is traditional debt-based financing with advantages for small business owners. These loans provide up to $5 million in small business funding, which can be used for starting a new business or franchise, purchasing an existing business, expanding operations, buying equipment or used as working capital. Though these loans are approved and funded through individual banks, the SBA guarantees 50 to 90 percent of the loan if it goes into default, which is why lenders are willing to offer favorable terms and conditions to small business owners.
Types of SBA Loans Available to Small Business Owners
Fortunately, the SBA offers more than one type of loan — providing opportunities for business owners in specific markets, unique situations or in need of smaller funding amounts. Here’s a high-level overview of the seven types of loans offered through the SBA lending program:
As the SBA’s most popular lending option, 7(a) loans offer up to $5 million in funding, which can be used for just about every business purpose. SBA 7(a) loans are one of the most affordable options offered because they typically have low interest rates of 7 – 9.75 percent and long repayment terms of up to 10 years (25 years for commercial real estate). The interest rate will change as prime goes up. Most loans max at WSJ Prime + 2.75%, but smaller loans all for higher rates up to WSJ Prime + 4.75%.
Because the SBA 7(a) approval process can take months, the SBA offers an Express Loan program for those in need of faster funding. The Express Loan has a maximum funding amount of $350,000, stricter eligibility requirements, slightly higher interest rates (the SBA only guarantees 50 percent of these loans), but initial approval is completed in a matter of days and total funding in only a few weeks. The speed of this loan work best for existing businesses or a service based business without a location, ie, someone who already has everything ready to open. A start up with a build out will take longer than a few weeks to fund.
In an effort to support and promote economic development, the SBA partnered with the certified development companies (CDC) to offer 504 Loans. These loans must be used to fund fixed assets, such as purchasing existing buildings or building new facilities, which are at least 51 percent owner-occupied and offer repayment terms of up to 10 and 20 years.
For those seeking short-term working capital, a line of credit through the SBA CAPLines program may be a good fit. CAPLines covers four different credit programs, which are all offered in conjunction with a 7(a) or 504 loan. These programs all have very low interest rates (5.75 – 8.25 percent), but short repayment terms up to five years.
Business owners engaging in international transactions may qualify for an SBA Export loan. The interest rates and repayment terms can vary greatly for Export loans and are only available to businesses that have been in operation for over a year and export products overseas.
With a burgeoning audience of home-based, online and freelance business owners who often require less funding to launch or grow their businesses, the SBA now offers a Microloan program. Microloans can be used for most business purposes, outside of paying existing debts and purchasing real estate. Unlike other SBA programs, Microloans are funded through the SBA, but are approved and originated through non-profit intermediary lenders.
Hopefully, you never find yourself the victim of a natural or economic disaster. But if you do, the SBA offers support in the form of Disaster loans. Businesses that can provide proof of negative impact resulting from a disaster can receive up to $2 million in financing with rates as low as four percent.
Understanding Your Loan Terms
Anytime you make a significant financial commitment impacting your business, it’s crucial to understand exactly what you’re agreeing to. And while loan terms can seem foreign and intimidating, even the financially adverse can quickly grasp the basics. Let’s take a look at some common loan terminology:
Interest Rate: With all debt-based financing, the amount you repay to the lender will total more than the amount you originally borrowed. How much you repay in total will depend on your interest rate and term of the loan. The interest rate is a percentage of your principal (loan amount) and is applied to the total unpaid amount. For example, in the simplest terms, if you borrow $100 with 20 percent interest, you would owe $120. However, when it comes to loans spread out over time, that same $100 with a 20 percent interest rate over 10 years (with a monthly payment) results in you paying a total of $231.91 over the life of the loan. SBA interest rates are set based on the daily prime rate (set by The Federal Reserve) plus the lender’s spread. Your interest rate can either be fixed, meaning it will stay the same for the lifetime of the loan or variable, meaning it can fluctuate over time. Knowing which you agreed to is crucial in financial planning.
Down Payment: The down payment, or equity injection, is the amount of cash you will contribute to the project. If you’re buying a $1 million dollar business, but have $200,000 of your own money to invest, you can make a 20 percent down payment. Making a substantial down payment is a requirement of all SBA loan programs. Though the requirements range from approximately 10 to 30 percent of the principal, the inability to make a large enough down payment can disqualify you from being approved.
Closing Costs: Depending on the type of SBA loan you qualify for, the closing costs and fees will vary. SBA 7(a) loans have a guaranty fee, which ranges from 2 – 3.5 percent of the SBA-guaranteed portion of the loan (typically around 75 percent of the total loan cost). SBA 504 loans have no guaranty fee, but for these loans, lenders charge a loan origination fee up to 3.5 percent of the total loan amount. Additional costs to consider may include packaging fees, loan broker fees, appraisal fees and business valuation fees. Most lenders will wrap the closing costs into the Total Project Cost so the borrower doesn’t have to pay them out of pocket, but take all of these costs into consideration when calculating how much cash you’ll need available in addition to your down payment in case your lender wants to to come to the table with them.
Repayment Schedule: Included in your loan terms is a repayment schedule, also known as an amortization schedule. You may be able to save money on interest payments if you can afford to pay the loan back over a shorter timeframe, but your monthly payments could be more manageable over a longer time period.
Signing a Personal Guaranty
As is common in debt-based financing arrangements, most SBA lenders require business owners to sign a personal guarantee to be approved for a loan. The personal guarantee, which is required for all business owners with a 20 percent or more equity ownership, is an agreement to use personal assets to cover the loan if the business can’t pay it back. In other words, if the business fails while the loan is still being repaid, the owner(s) become personally responsible for the remaining loan amount. So, as a part of the guarantee, there could be a lien on the owner’s personal assets, including residential real estate. Personal guarantees are binding regardless of your entity type, C-Corps, S-Corp, LLCs, etc, will still have to sign a personal guarantee.