SBA 7(a) loans and SBA 504 loans are two of the most popular types of loans available to current and prospective American small business owners. They’re both SBA loans, meaning they’re partially guaranteed by the U.S. Federal Government’s Small Business Administration, and they’re both great financing options due to their wide availability and favorable terms. However, there are also many important differences between them.
Loan Structure
SBA 7(a) loans have a straightforward loan structure: one lender, one loan. SBA 504 loans, on the other hand, have a more complicated loan structure, with two lenders and two loans. The two lenders are a Certified Development Company (CDC) and a third-party lender (usually a bank or credit union), each of which does their own analysis of the borrower and business. Notably, the third-party lender loan has few restrictions (closer to a conventional loan), so the lender is free to do almost whatever they want with it.
In a typical 504 loan, the down payment is 10% of the total project cost, the CDC’s loan is 40%, and the third-party lender’s loan is 50%. The CDC’s loan is guaranteed by the SBA, while the third-party lender’s loan has the first deed of trust on the real estate involved. This system allows both lenders to fully recoup their loan’s value if the business fails.
Eligibility
Personal Eligibility
Personal eligibility is similar for both SBA 7(a) loans and SBA 504 loans. Both 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).
Business Eligibility
Business eligibility is similar for SBA 7(a) loans and SBA 504 loans. Both are available for almost all for-profit small businesses in the United States, with limited exceptions including private member clubs, banks, gambling businesses, and more.
Eligible Uses of Loan Proceeds
There’s a substantial difference between the eligible uses of loan proceeds for SBA 7(a) loans and SBA 504 loans. SBA 7(a) loans are eligible for almost all uses, including business acquisition, debt refinance, working capital, construction, and more. The few ineligible uses include purchasing investment properties (residential or retail), paying back taxes, and more.
SBA 504 loans, on the other hand, have much fewer eligible uses of proceeds, limited to loans involving real estate (the purchase, construction, or improvement of buildings or land), the purchase of long-term equipment, or the refinance of a real estate or equipment loan.
Attainability
SBA 7(a) loans and SBA 504 loans have similar attainability, both being accessible to most borrowers. The purpose of the 7(a) and 504 programs is to provide an alternative path to financing for American small businesses unable to receive conventional loans, so 7(a) and 504 loans are designed to be as widely attainable as possible.
Loan Terms
Interest Rate
A key difference between SBA 7(a) loans and SBA 504 loans is their interest rates, as SBA 7(a) loans have higher interest rates than SBA 504 loans. This is due to 7(a) rates being based on the Prime Rate – they usually 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).
SBA 504 loan rates aren’t based on the Prime rate – instead, the two loans that make up the SBA 504 loan have differing interest rates. The CDC loan’s rate is (indirectly) based on treasury bond rates, which are typically lower than the Prime Rate. The third party lender’s rate can technically be anything, but also tends to be lower than the Prime Rate. As both individual rates are usually lower than the Prime Rate, the effective interest rate of the entire loan is usually lower than the Prime Rate.
Importantly, however, 504 loans are usually fixed rate loans, as the CDC loan is fixed, and the third-party lender loan is usually fixed (but can be either fixed or variable). On the other hand, while 7(a) loans can have fixed rates, they typically have variable rates. This can be a positive or a negative – when rates are lower and/or going up, getting a fixed rate loan is best, but when rates are higher and/or coming down, getting a variable rate loan is ideal.
Loan Term
SBA 7(a) loans and SBA 504 loans have the same maximum (and typical) loan terms: 25 years for loans involving real estate, and 10 years for loans not involving real estate. As 504 loans are designed for loans involving real estate, most 504 loans have 25 year terms, with only long-term equipment loans having 10 year terms.
Maximum Loan Amount
SBA 7(a) loans have a maximum loan amount of $5,000,000. SBA 504 loans don’t technically have a maximum loan amount, as the only size restriction is on the CDC loan – the third-party lender loan can be any size. However, most lenders stick to the standard formula of the CDC loan being 40% and the third-party lender loan being 50% of the total project cost, so in most cases a 504 loan’s maximum loan amount is $12,500,000.
Down Payment
SBA 7(a) loans and SBA 504 loans both have the same minimum down payment: 10%. However, in reality 7(a) loans tend to have higher down payments (although it depends on the lender). 504 loans, on the other hand, only have down payments higher than 10% if the business is new/a startup or the real estate is a special purpose property (built for one type of business and can’t be easily converted for another type). If one of those two things is true the down payment is 15%, if both are true it’s 20%.
Collateral
SBA 7(a) loans and SBA 504 loans both require full collateralization, if possible. This is much easier for 504 loans, as the real estate involved is usually all that’s needed. It can be much more difficult to reach full collateralization for 7(a) loans, especially those not involving real estate. The lender will take all available collateral, often extending beyond the business to include the borrower’s home or a new life insurance policy on the borrower. However, 7(a) loans aren’t meant to be rejected on the basis of under-collateralization, so although lenders will take all available collateral, the loan will still likely be approved even if it can’t be fully collateralized.
Amortization
Both SBA 7(a) loans and SBA 504 loans are fully amortized, meaning borrowers will make the same payment for the entire length of the loan, other than the effects of interest rate changes for variable rate loans.
Prepayment Penalty Period
SBA 7(a) loans have short prepayment penalty periods of only three years (5%-3%-1%), making them easier to refinance in the short-medium term (and an effective bridge loan). SBA 504 loans have longer prepayment penalty periods, with the CDC loan’s being ten years and the third-party lender loan’s varying, from none at all to over ten years long.
Notably, any penalties must be paid when the real estate is sold. This makes it more difficult to sell the property within 10 years, regardless of the prepayment penalty period of the third-party lender loan.
Personal Guarantee
Both SBA 7(a) loans and SBA 504 loans formally require a personal guarantee from the borrower, meaning they’ll be personally responsible for the debt if the business fails.
Loan Security
Both SBA 7(a) loans and SBA 504 loans are fully secure (as long as the borrower doesn’t miss any payments). This means that the lender can’t structure the loan to give themselves an out (via balloon payment) at any point.
Loan Process
The loan process is an important point of difference between SBA 7(a) loans and SBA 504 loans. The SBA 7(a) loan process, which takes 2-3 months, can be slow compared to conventional loans. However, it’s notably quicker than the SBA 504 loan process, which takes 3-6 months and can be very cumbersome.
Such a large difference in loan speed can be attributed to two things. The first is 504 loans having two lenders, each of which does their own analysis of the loan. This means more paperwork, more questions, and more chances for delay.
The second is that the CDC loan is usually bundled with other CDC 504 loans in a debenture bond and sold to investors, the money from which is used to lend to the borrower. This means that unless the borrower gets a more expensive bridge loan from a different lender, they’ll only receive the CDC loan funds a month or two after the rest of the loan process is over.
Lenders
Both SBA 7(a) loans and SBA 504 loans are available from a wide variety of lenders all across the country. Over 1500 lenders complete a 7(a) loan each year, while over 180 CDCs and over 1300 third-party lenders complete a 504 loan each year.
Want to be connected with a great SBA 7(a) lender? 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 good fit for your loan.
Government Guarantee
SBA 7(a) loans and SBA 504 loans are both partially guaranteed by the U.S. Federal Government’s Small Business Administration (SBA). For SBA 7(a) loans, 85% of the loan amount is guaranteed for all loans <$150,000 and 75% of the loan amount is guaranteed for all loans >$150,000. For SBA 504 loans, only the CDC loan is guaranteed. As 504 loans are actually two loans, with the down payment usually making up 10% of the total project cost, the CDC loan usually making up 40%, and the third-party lender usually making up 50%, this means that typically, 44% of the total loan amount is guaranteed.
