SBA 7(a) loans and conventional loans are two of the most popular financing options for American small businesses. They’re both available to a wide variety of borrowers and for a wide variety of purposes. However, there are also many important differences between them.
Eligibility
Personal Eligibility
Personal eligibility is similar for both SBA 7(a) loans and conventional loans. SBA 7(a) loans are available to all borrowers, other than those convicted of some (but not all) felonies, those currently incarcerated or charged with a felony, and those who have caused a financial loss to the federal government (typically through a default on a past government-backed loan). Conventional loans are available to all borrowers.
However, each lender also has their own personal eligibility criteria, which is often more restrictive for conventional loans than SBA 7(a) loans. For instance, SBA 7(a) loans are usually more attainable than conventional loans for borrowers with a criminal record, lower credit score, or past personal bankruptcy.
Business Eligibility
Business eligibility is mostly similar for SBA 7(a) loans and conventional loans. SBA 7(a) loans are available for almost all for-profit small businesses in the United States, with exceptions including private member clubs, banks, gambling businesses, and more. Conventional loans are available for all businesses, no matter their profit status, size, or location of operations. However, each lender also has their own business eligibility criteria.
Eligible Uses of Loan Proceeds
Eligible uses of loan proceeds are nearly the same for both SBA 7(a) loans and conventional loans. SBA 7(a) loans are available for almost all uses, including business acquisition, debt refinance, working capital, construction, and more. However, there are a few ineligible uses, including purchasing investment properties (residential or retail), paying back taxes, and more. Conventional loans are even more broadly useful, being available for all uses of loan proceeds.
However, each lender also has their own preferred uses of loan proceeds.
Attainability
Perhaps the most important difference between SBA 7(a) and conventional loans is their attainability. Lenders are more willing to give SBA 7(a) loans than they are conventional loans, making SBA 7(a) loans easier and conventional loans more difficult to get. This difference in attainability is due to the SBA guaranteeing the majority of SBA 7(a) loans (75% for most loans), lowering the risk for the lender.
SBA 7(a) loans are much easier to receive for newer/financially weaker businesses, as well as riskier uses of loan proceeds like startup and construction.
Notably, only good, low interest rate conventional loans are less attainable than SBA 7(a) loans. High interest rate conventional loans, such as from a direct lender, a risk-taking bank, or the usage of credit cards, are easily attainable. However, their interest rates being even higher than those of SBA 7(a) loans (thus losing the main benefit of conventional loans, a lower interest rate) means they’re an inferior option.
Loan Terms
Interest Rate
A key difference between SBA 7(a) loans and conventional loans is their interest rates. It varies from loan to loan, but SBA 7(a) loans tend to have higher interest rates than conventional loans. This is due to 7(a) rates being based on the Prime Rate – they range between Prime + 1% and Prime + 3%, restricting them to a narrow band of high interest rates (for most 7(a) loans – they can be higher than Prime + 3 for loans <$350,000). Conventional loans aren’t required to stay within such a range, so their rates tend to be a bit lower. However, this lack of restrictions means that rates can also be higher.
Loan Term
The difference in loan terms between SBA 7(a) and conventional loans can be large. SBA 7(a) loans have maximum terms of 25 years for loans involving real estate and 10 years for loan not involving real estate, and these maximums are typically used. Conventional loans, on the other hand, tend to have shorter terms than these.
With conventional loans, a loan typically has two terms: the amortization term and loan term. The amortization term (the term the loan payments are based on) is longer, while the loan term itself is shorter, with a balloon payment for the loan’s outstanding balance coming at the end of a term (if not renewed). These shorter loans, which are typically five years long (but can range from 1-10 years), can be renewed multiple times until the loan is paid off. This design is meant to establish the framework for a long-term loan if everything goes well, but also give the lender outs if the business is underperforming.
Maximum Loan Amount
SBA 7(a) loans have a maximum loan amount of $5,000,000, while conventional loans don’t have a maximum loan amount.
Down Payment
SBA 7(a) loans tend to have lower down payments than conventional loans. Although SBA 7(a) loans have a minimum down payment of 10% and conventional loans don’t technically have a minimum down payment, each lender has their own minimum down payments that are usually higher for conventional loans than 7(a) loans.
Collateral
SBA 7(a) loans and conventional loans will, if possible, require the same level of collateral, as lenders generally treat them the same collateral-wise. However, a key caveat is that SBA 7(a) loans are not meant to be rejected on the basis of under-collateralization, so they’re often the better/only option for borrowers without large amounts of collateral.
Amortization
SBA 7(a) loans are fully amortized, meaning all payments are the same size for the entire term of the loan (other than the effects of interest rate changes). Conventional loans, on the other hand, are usually partially amortized, meaning they have two different terms: the amortization term and loan term. The amortization term (which the loan payment is based on) is longer, while the loan term is shorter and comes with a balloon payment of the remaining loan balance at the end (if not renewed). The shorter term can then be renewed until the loan is paid off. This system is meant to give the lender built-in outs, and if one of these outs is taken, the borrower has to pay the balloon payment. This necessitates a loan refinance, which is often done via an SBA 7(a) loan.
Prepayment Penalty Period
SBA 7(a) loans have prepayment penalty periods of three years (5%-3%-1%), while the prepayment penalty periods of conventional loans tend to be longer. This means it’s easier to refinance an SBA 7(a) loan in the short-medium term, making it an effective bridge loan. A common plan is to get an SBA 7(a) loan first for a startup loan, construction loan, or a newer/weaker business, then refinance into a conventional loan with a lower rate after a few years of good performance.
Personal Guarantee
Both SBA 7(a) loans and conventional loans require a personal guarantee. It’s formally required for SBA 7(a) loans, and while it’s technically not necessary for conventional loans, the lender almost always requires it.
Loan Security
Loan security is a key difference between SBA 7(a) loans and conventional loans. As long as the borrower is making their payments, SBA 7(a) loans are fully secure, with the interest rate and payment size locked in for the entire length of the loan (other than interest rate changes and their effects, if the loan has a variable interest rate).
With conventional loans, however, this isn’t always the case. It’s common for conventional loans to be structured not as one loan, but as a series of shorter loans that must be renewed every time one ends. This gives the lender built-in outs in the loan that, if taken, force the borrower to immediately pay a balloon payment of the remainder of the loan balance, necessitating a refinance. The lender can do this for any reason (such as the business performing poorly, the lender being bought/merging with another lender, and the lender wanting to change the makeup of their loan portfolio), even if the borrower makes all their payments. Additionally, conventional loans sometimes build in increases in interest rates if the borrower misses a payment.
Loan Process
The loan process is an important point of difference between SBA 7(a) loans and conventional loans. The SBA 7(a) loan process is slower and more cumbersome due to its stricter guidelines and additional documents . The 7(a) loan process can be expected to take between 2-4 months, while the conventional loan process can be expected to take between 4-6 weeks. This can be a factor in the decision between a 7(a) and conventional loan, especially if speed is crucial.
Lenders
Both SBA 7(a) loans and conventional loans are available from a wide variety of lenders all over the country. 7(a) loans are offered by fewer lenders than conventional loans (which are offered by nearly all lenders), but with over 1500 SBA 7(a) lenders, there are plenty of options.
However, the more niche nature of SBA 7(a) loans and their cumbersome loan process means that borrowers must choose a lender that’s experienced with 7(a) loans, as it can make the loan process quicker and smoother. Luckily, 7aSavvy can help – just fill out our Get Connected form and we’ll connect you with an experienced SBA 7(a) lender who’s a great fit for your loan.
Government Guarantee
SBA 7(a) loans are majority guaranteed by the U.S. Federal Government’s Small Business Administration (SBA), with 85% of the loan amount guaranteed for all loans <$150,000 and 75% of the loan amount guaranteed for all loans >$150,000. Conventional loans, on the other hand, don’t have a guarantee. The SBA guarantee lowers the risk for lenders, making them more willing to give out 7(a) loans than conventional loans.
