The Small Business Administration (SBA) does not issue loans; rather, it acts as a loan guarantor, working with lenders to help businesses obtain financing. For 504 financing, the SBA works in concert with Certified Development Companies (CDCs) which are non-profit corporations established to contribute to the economic development of local communities. A qualified business with an eligible financing need will receive up to 40% of SBA-backed financing from a CDC and up to 50% from a private lender that has been paired with the CDC. The business borrower is required to put up the remaining 10%. The private lender takes a senior lien position on the loan.
What Can an SBA 504 Loan Be Used For?
The SBA limits the uses of 504 loan proceeds for larger projects intended specifically to expand the business. SBA 504 loans uses can include:
- Buying real estate or developing real property (the borrower must occupy at least 51% of the property)
- Property improvements or facility upgrades
- New construction
- Long lifespan, heavy equipment
Loans cannot be used for working capital, debt refinance or small equipment purchases. For those purposes, businesses should apply for an SBA 7(a) loan.
What are SBA 504 Loan Qualifications?
For a business to be eligible for SBA 504 consideration, it must meet the loan public policy goals established by the SBA, which apply to job creation, community development and other public policy goals. For its job creation goal, the SBA requires that the business be able to create or retain one job for every $65,000 that is borrowed. For small manufacturers, the goal is one job for every $100,000 that is borrowed.
If job creation is not the primary intent of the loan, the business must use the proceeds in a way the advances community development goals, such as promoting business district revitalization, rural development, energy efficiency or the expansion of minority, women or veteran owned businesses. A more comprehensive list of public policy goals can be found on the SBA website.
Businesses must then meet the SBA’s credit and financial qualifications, which include:
- Good to excellent credit
- A 10% down payment of the project cost
- Have a net worth less than $15 million
- Average net income of less than $5 million over the prior two years
- Not have alternative sources of funds
- Demonstrate the ability to repay the loan from projected cash flow
What are the Terms and Rates of an SBA 504 Loan?
When taking out an SBA 504 loan, a business is actually taking out two separate loans – the government-backed CDC loan for up to 40% of the project cost and the private loan for up to 50%. The terms of the CDC portion of the loan are set by the SBA, which allows for loan terms of 10 or 20 years. The rate limits are also set by the SBA, which pegs the rates to U.S. Treasury notes. As of October 14, 2016, the fixed rate for a 10-year CDC loan is 3.2% and 3.7% for a 20-year CDC loan. Additional fees can be charged by the lender.
For the private lender portion of the loan, the lenders set the terms and the rates. The loan terms are typically set for five to 10 years but amortized over 20 to 25 years, resulting in a lower payment with a large balloon when the loan matures. The interest rates charged are typically based on market rates, which, as of October 2016, range from 4 to 8% depending on the creditworthiness of the business, the loan amount and the loan term.
How to Apply for an SBA 504 Loan
Business applying for an SBA 504 loan can expect a lengthy and arduous process. In addition to dealing with the government bureaucracy, the business has to work with two separate entities – the CDC and the private lender (or lenders). There are two ways a business can begin the process. The first is to use the SBA’s online search engine to locate a CDC in the area. The CDC is where the qualification process begins and, if a business makes it to the next step, the CDC should be able to recommend private lenders in the areas.
Alternatively, if a business works with a local bank designated as an SBA lender, the lender can provide the guidance needed to start the process and then refer it to a local CDC. Either way, it is important for the business to work with a lender that specializes in SBA loans for the easiest navigation of a complex process.