SBA 504 vs. 7(a) Loan Comparison

SBA 504 loans and SBA 7(a) loans are both types of business loans that are guaranteed by the U.S. Small Business Administration (SBA). The loan amounts, terms, and permissible uses vary for each of these programs. You’re more likely to use an SBA 7(a) loan for working capital or business expansion, and an SBA 504 loan to finance the purchase or improvement of commercial property or equipment.

While there are some grey areas, it’s usually quite clear which loan—the SBA 504 or the 7(a)—is right for a small business. Keep reading to dig further into the differences between an SBA 504 vs. 7(a) loan to find out which one to choose for your business.

For most small business owners who are trying to select among the different types of SBA loans, the 7(a) loan is the best option. The SBA 7(a) loan is a flexible, low-interest-rate business loan that’s suitable for a variety of business needs.

The SBA itself is not in the business of lending. Rather, the SBA partially guarantees business loans made by banks and other private SBA lenders. The partial guarantee lowers a lender’s risk of extending capital to small business owners and incentivizes lenders to approve applicants that they might otherwise reject. A bank or other direct lender will underwrite and issue your SBA 7(a) loan.

Along with the above uses, any of the following are also eligible uses for an SBA 7(a) loan:

• Purchasing, constructing or renovating a commercial property (most investment property is excluded, however)

• Acquiring fixed assets, such as equipment, fixtures, or furniture

• Working capital, such as purchasing inventory or supplies

• Purchasing land for a business

The bank issuing the 7 (a) loans has the discretion to set its own eligibility criteria. In most cases, SBA lenders require a strong personal credit score (650+) and a demonstration of your ability to repay the loan, evidenced by historical business revenue or documented cash flow projections. They’ll also require a down payment of 10% to 20%.

There’s technically no minimum loan amount set by the SBA, but obtaining loan amounts at the very low end of this spectrum can be hard because lenders don’t earn much profit from small loans.

The repayment time frame depends on what you’ll use the loan funds for. If you’re using an SBA loan for working capital, then the term is up to 10 years. Working capital encompasses uses like business expansion and buying inventory. A 10-year term also applies to equipment and machinery, but the term can’t exceed the expected useful life of the tool that’s being financed. If you’ll be using a 7(a) loan to purchase, construct, or make improvements to real estate, you’ll enjoy up to 25 years to repay your loan.

The typical SBA 7(a) loan has a variable interest rate and monthly payments of principal and interest. The latest SBA loan rates always represent a spread over the Prime Rate, which is a market rate that fluctuates based on how the economy is doing. SBA 7(a) loan rates are similar to the rates on conventional bank loans and represent some of the most affordable options for small businesses. That said, since the interest rate is variable, rates can go up or down while your loan is outstanding.

The primary fee on an SBA 7(a) loan is the SBA guarantee fee. The SBA charges the guarantee fee to ensure that the government has money to reimburse the lender if the business can’t pay back the loan.

Currently, the SBA guarantee fee is as follows:

• Loans of $150,000 or less: 2% fee on the guaranteed portion

• Loans of $150,001 to $700,000: 3% fee on the guaranteed portion

• Loans of $700,001 to $5 million: 3.5% fee on the guaranteed portion on amounts up to $1 million, plus 3.75% fee on the guaranteed portion over $1 million.

Note that this fee is charged on the guaranteed portion of the loan. For example, if you get a $150,000 loan, the SBA will guarantee up to 85% of that loan—or $127,500. That means you’ll owe a guarantee fee of 2% on that latter amount—or $2,550. There’s also a small service fee that you have to pay annually.

Keep in mind that your bank will likely charge additional fees, such as loan packaging fees and closing fees. Such fees will increase your overall borrowing cost.

Most SBA 7(a) loans require collateral of some sort. For larger loans, the SBA requires the lender to place a lien on all assets that are financed with the loan, as well as any existing fixed assets of the business.

If the loan isn’t fully secured at that point, the bank might also place a lien on the business owner’s personal residence or other personal property.

In addition to collateral, anyone who owns 20% or more of the business must sign a personal guarantee. By signing a personal guarantee, you are making a personal promise to pay back the loan if your business’s assets don’t sufficiently compensate the lender.

The SBA 504 loan, more formally called an SBA 504/CDC loan, is a more specialized loan than the 7(a) loan. The 504 loan is designed for business owners who need to finance the acquisition or improvement of fixed assets—such as land, buildings, or equipment—and whose projects promote economic development or other public policy goals.

The SBA 504 loan has a more complicated structure than the SBA 7(a) loan, comprising three parts:

• Bank loan (50%): A bank or other direct lender extends 50% of the loan amount

• CDC loan (40%): An SBA-approved Certified Development Company (CDC) extends 40% of the loan amount

• Borrower down payment (10%): The borrower puts up 10% of the loan as a down payment

Owners of startups and special use properties must put up higher down payments. CDCs are local nonprofit lenders that promote economic development in their communities by participating in SBA 504 financing. The SBA certifies and regulates CDCs.

The funds from a 504 loan can only be used for properties that are at least 51% owner-occupied (for existing facilities; 60% for new construction). In other words, if your building has 1,000 square feet, your business must occupy and use at least 510 square feet. You can lease out the remaining space to other businesses. In contrast to an SBA 7(a) loan, an SBA 504 loan cannot be used for working capital or for buying inventory or supplies.

The job creation/retention or public policy requirement is unique to the SBA 504 loan program. For every $75,000 that the CDC lends, the applicant business must create or retain at least one job (small manufacturers have to meet a higher job creation/retention goal). Three-quarters of the jobs created or retained must be in the local community. If you’re not able to show that you meet the job creation or retention requirements, there are other public policy goals that you can meet instead, such as furthering the growth of minority or women-owned businesses or reducing energy consumption.

The typical business owner has to put just 10% down on an SBA 504 loan. However, if you have a startup (fewer than two years of consecutive operating history) or a special use property (such as an amusement park or gas station), you’ll have to put down 15%. If your business is classified as a startup and a special use property, the down payment increases to 20%.

On top of the requirements detailed above, the bank and the CDC issuing the loan can set additional requirements. As with 7(a) loans, SBA 504 lenders require strong personal credit and a demonstration of your ability to repay the loan, evidenced by historical business revenue or documented cash flow projections.

The SBA 504 loan is ideal for large business investments. There’s no limit on the bank portion of the loan, so 504 loans technically have been funded for upward of $20 million.

Your repayment term on an SBA 504 loan will be 10, 20, or 25 years. If financing equipment, the term depends on the expected useful life of the equipment. The term will be 20 or 25 years for other uses, so you can expect low monthly payments.

Whereas the SBA 7(a) loan is a variable-rate loan, SBA 504 loans are fixed-rate loans. The advantage of fixed-rate financing is that your rate is locked in for the life of the loan. This is one of the biggest benefits that the SBA touts for 504 loans.

SBA 504 loan rates are among the lowest interest rates you can find on small business financing, even lower than SBA 7(a) loans. The interest rates on SBA 504 loans are pegged to the rates on U.S. Treasury bonds.

There are a few more fees on SBA 504 loans compared to 7(a) loans. SBA 504 loans come with four main fees:

• SBA upfront guarantee fee – The SBA charges a 0.5% upfront fee to the borrower.

• SBA annual service fee – The SBA charges an annual service fee of 0.368% to the borrower, which is applied to the loan’s outstanding principal balance.

• CDC processing fee – The CDC charges a 1.5% upfront processing fee to the borrower.

• CDC servicing fee – The CDC also charges an annual servicing fee between 0.625% and 2% per year, assessed on the loan’s outstanding principal balance.

Keep in mind that the CDC or bank can charge additional fees, such as loan underwriting fees and closing fees. These fees will increase your overall borrowing cost.

Most SBA 504 loans are self-secured, meaning that the underlying fixed assets serve as collateral. There’s typically no need to provide additional collateral above and beyond what you’re already acquiring with the funds.

Anyone who owns 20% or more of the business must sign a personal guarantee on both the CDC and bank portion of the 504 loan. Remember, even business owners with a solid credit history and excellent financials will have to sign a personal guarantee for the lender’s security. If your business defaults and cannot compensate the lender, the personal guarantee permits the lender to pursue loan repayment directly from the business owner’s personal assets.

Choose the SBA 7(a) loan if:

• You need working capital to buy inventory, supplies, or fill cash flow gaps

• You need less than $5 million in financing

• You prefer a faster SBA loan application process

The SBA 7(a) loan program also has sub-programs that might be suitable for your business, such as Community Advantage Loans designed for women, minorities, and other underserved entrepreneurs. To get started with an SBA 7(a) loan, apply here.

Choose the SBA 504 loan if:

• You need financing to purchase, lease, renovate, or improve commercial real estate, buildings, or equipment.

• You’re making a large investment in your business.

• You’re able to show that you meet job creation, job retention, or public policy goals.

• You’re okay with a slower loan application process.

• You can only afford a 10% down payment.

To get started with an SBA 504 loan, use the SBA’s Lender Match tool. This can help you find a bank and a CDC that participate in SBA 504 financing.

When you are considering a small business loan, there are several options to choose from. The SBA 7(a) loan fits a wide variety of business needs and is an especially good option if you are looking for working capital. The SBA 504 loan is more niche and designed for real estate investments and other fixed assets. Whichever you end up choosing, both the SBA 504 loan and 7(a) loan are excellent opportunities for small business owners searching for affordable financing.