SBA 504 VS 7(a) Loans: Which Is Right For Your Small Business?

Loans from the Small Business Administration are some of the most highly sought-after financing options by small business owners. SBA loans provide benefits for both the borrower and the lender. Small businesses get to take advantage of competitive interest rates and excellent terms, while intermediary lenders can feel confident in loaning money through these government-backed programs. Because these loans are backed by the government, there’s less risk for lenders, opening up more opportunities for small business owners who may not qualify for traditional loans.

However, the process of choosing an SBA loan can be confusing for small business owners. These loans aren’t “one-size-fits-all” and different programs are available, each with their own terms, rates, and requirements. Two of the most popular loans provided through the SBA are the 504 loans and 7(a) loans. Business owners not well-versed in SBA loans may be unsure of which loan to choose, so it’s important to break down the differences between the two in order to move toward making the right financial decision.

SBA 504 VS 7(a) Loans: Loan Uses

SBA 7(a) Loans SBA 504 Loans
  • Working capital
  • Commercial real estate purchasing
  • Equipment purchasing
  • Purchasing a pre-existing business
  • Refinancing debt
  • Purchase an existing building
  • Purchase land and land improvements
  • Construct new facilities
  • Renovate existing facilities
  • Purchase machinery and equipment for long-term use
  • Refinance debt in connection with renovating facilities or equipment

The SBA 504 program has very specific guidelines as to how loan proceeds can be used. This program provides funding for fixed assets that are used to expand or update a small business. This includes commercial real estate, land, and long-term machinery purchases. Land improvements such as grading and landscaping can also be financed, as well as renovations to commercial buildings or the construction of a new building. Proceeds from the SBA 504 loan can also be used to refinance prior debts related to updating or constructing new facilities.

The SBA’s 7(a) loan is more flexible in terms of how the proceeds can be used. These loans can be used for just about any business expense. A 7(a) loan can be used to purchase equipment, fixtures, and inventory. It can be used to refinance existing debt or as working capital for the business. A 7(a) loan can also be used to purchase real estate or land, or renovate existing buildings and land, similar to the 504 loan.

SBA 504 VS 7(a) Loans: Borrower Requirements

SBA 7(a) Loans SBA 504 Loans
  • For-profit business considered “small” by the SBA
  • Engaged in business in the United States
  • Not in an ineligible industry
  • Strong personal and business credit
  • Strong business financials
  • Strong business plan
  • For-profit business
  • Tangible net worth less than $15 million
  • Average net income less than $5 million
  • Engaged in business in the United States
  • Not in an ineligible industry
  • Strong personal and business credit
  • Strong business financials
  • Strong business plan

SBA 504 Requirements

To qualify for an SBA 504 loan, borrowers must find an SBA-approved Certified Development Company to fund 40% of the project. Another lender, such as a bank or credit union, must provide 50% of the project’s cost. The borrower will be responsible for paying the remaining 10% of costs.

Borrowers of the 504 loan must own a small business according to the size standards of the SBA. The SBA imposes limits on the number of employees you can have to qualify as a small business. These numbers vary by industry, but the organization has created an easy-to-use size standards tool to determine if a business qualifies for loans and other resources. The business must also have a net worth of less than $15 million and an average net income of less than $5 million for the previous two years.

To qualify for an SBA 504 loan, a business must be for-profit. Businesses that engage in passive, speculative, or non-profit activities are disqualified from receiving funding through the 504 program. All qualifying small businesses must be based in the United States.

While there is no minimum credit score required to qualify for an SBA 504 loan, a strong score raises a business owner’s odds of approval. A score of 680 is typically recommended but not required. Credit reports should be free of bankruptcies, foreclosures, and past defaults on government-backed loans.

Applicants for the 504 loan program will be required to submit documentation with their application. This includes but is not limited to personal financial statements, federal income tax returns, balance sheets, and income statements. Cost documentation, including contractor estimates and real estate purchase agreements, will also need to be submitted with the application. New businesses in operation for less than 2 years will be required to submit a cash flow analysis.

Applicants will be required to submit a letter of intent from their lender stating that they will be providing 50% of the project costs. The lender also must specify why they will not fund the full cost of the project.

All existing buildings purchased with 504 loan proceeds or a refinanced building must be at least 51% owner-occupied. If a building is being constructed, it must be at least 60% owner occupied upon receipt of the loan and increase to 80% by the 10th year.

SBA 7(a) Requirements

Requirements for the 7(a) loan are very similar to the requirements for 504 loans. Borrowers must show a need for the money and all other financing options must have been exhausted prior to applying for the 7(a) loan. Borrowers must also show that they are considered a small business based on the SBA’s standards. All borrowers must be for-profit businesses based in the United States.

There is no set credit standard in place but as with other SBA programs, borrowers should have a strong credit score and a credit report free of foreclosures, bankruptcies, and defaults on government-backed loans. All negative items reported will need to be explained to the lender in order to qualify for 7(a) loans. A score of at least 680 is recommended for all applicants. Learn more about boosting your credit score to qualify for SBA loans and other financing options.

The documentation required to apply for a 7(a) loan includes, but is not limited to, federal income tax returns, financial statements, income statements, and balance sheets. Real estate purchase agreements are required when real estate is being bought with loan proceeds. If debt is to be refinanced with the 7(a) loan, notes, leases, and payment transcripts for the last 3 years will be required.

Don’t qualify for an SBA program? Don’t worry — there are more options available. Check out this comparison of small business loans that may fit your needs.

SBA 504 VS 7(a) Loans: Rates & Terms Comparison

SBA 7(a) Loans SBA 504 Loans

Borrowing Amount

Max. $5 million

No maximum, but the SBA will only fund up to $5 million

Term Lengths

7 – 25 years

10 or 20 years

Interest Rates

Variable rate of a base rate plus a markup of 2.25% – 6.5%

Fixed rate based on US Treasury rates

Borrowing Fees

Guarantee fee, other fees from lending partners

CDC servicing fee, CSA fee, guarantee fee, third party fees (most fees are rolled into the interest rate or cost of the loan); possible prepayment penalty

Personal Guarantee

Guarantee required from anybody who owns at least 20% of the business

Guarantee required from anybody who owns at least 20% of the business

Collateral

Collateral required; specifics vary based on business and loan use

Collateral required; usually the real estate/equipment financed

Down Payment

10%

10% – 30%

Borrowing Amounts

The maximum amount that can be borrowed under the SBA 504 loan program is $5 million. An SBA-approved CDC will loan up to $5 million to cover 40% of the total project costs. As previously mentioned, another lender will cover 50% of the costs, while the borrower will fund the remaining 10%.

Through the 7(a) program, up to $5 million can be borrowed through an SBA-approved lender.

Loan Term Lengths

Term lengths for 504 loans vary based on how loan proceeds will be used. Equipment purchases come with a repayment term of 10 years, while real estate has a maximum term of 20 years.

SBA 7(a) loans also have different terms based on how funds will be used. Repayment terms for equipment are up to 10 years, while 25-year terms are available for the purchase of real estate.

Interest Rates

Interest rates for 504 loans are based on the rates of 5-year and 10-year Treasury issues. Interest rates for the remaining 50% funded by the other lender will vary.

Interest rates for 7(a) loans are based on the prime rate plus an additional percentage not to exceed 6.5%. Interest rates are determined by the repayment terms and borrowed amount.

Other Fees

Borrowers that take out a 504 loan may have to pay various fees based upon the policies of the lender. This includes origination fees up to 3.5%, packaging fees, broker fees, and closing costs. Fees can be added to the cost of the loan.

SBA 7(a) loans come with a guarantee fee, though for loans of $150,000 or less, there are no guarantee fees. Fees of up to 3.75% are charged to borrowers based on the total amount of the loan for any amount over $150,000. Additional fees may be assessed, including but not limited to origination fees, packaging fees, and appraisal fees for collateral.

Personal Guarantee & Collateral

SBA 504 loans require all owners with a 20% or more stake in the business to sign a personal guarantee. Collateral is typically not required. Instead, the project being funded serves as the collateral for these loans.

Personal guarantees by all owners will also be required when applying for a 7(a) loan. Loans of $25,000 or less do not require collateral. Loans up to $350,000 are subject to the lender’s policies. Loans that exceed $350,000 will require adequate collateral valued up to the total amount of the loan. If business assets are not available to fully collateralize the loan, personal real estate can be used. It’s also important to note that an intermediary will not reject an application solely based on the lack of collateral.

Down Payment

A down payment is required for the SBA 504 loan. Generally, this amount is just 10%. However, in some cases, such as with a startup business that has been operating for 2 years or less, the down payment could be as high as 30%.

A down payment is also required for the SBA 7(a) loan program. Down payments for this loan program are typically 10%.

When Should I Apply For An SBA 504 Loan?

An SBA 504 loan is best for businesses that are looking to expand through new or updated facilities. The down payments required for this loan are typically lower than those for other forms of financing, while interest rates and repayment terms are some of the best for commercial real estate.

Because these loans are backed by the government, they are also much easier to obtain than other means of financing, like commercial bank mortgages. Read on to find out more about 504 loans and how they can benefit your business.

When Should I Apply For An SBA 7(a) Loan?

The SBA 7(a) loan is one of the best loans for any business purpose. Whether it’s for working capital, purchasing inventory, or other business expenses, the SBA 7(a) loan is one of the best small business loans available thanks to low interest rates and long repayment terms. Small businesses with legitimate needs for funding and strong credit won’t go wrong by obtaining an SBA 7(a) loan.

SBA 7(a) loans are great for most businesses, including startups, because lenders are more willing to loan money under this program. Up to 85% of funds are backed by the government, providing lenders with security and confidence to lend while giving small business owners a low-cost loan option. Find out more about SBA 7(a) loans to determine if this is the right funding option for your business.

Final Thoughts

SBA 504 loans and 7(a) loans both offer benefits for small business owners. Both loan options should be evaluated carefully to determine which is best for a business’ needs, and in some cases, other business loans may be a better fit. With responsible borrowing, the SBA loan programs and other loans offer benefits that can take a small business to the next level of success.

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