Expert tips on picking the right small business loan for you – SBA 504 vs SBA 7a?

SBA Small Business Loan
March 1, 2018

If you’re starting or growing a business and need funding, you’ll likely come face-to-face with SBA 504 and SBA 7a loans. They’re by far two of the SBA’s most popular programs. When leveraged correctly, they can provide a slew of benefits to your business.

The onslaught of guidelines for both options can easily overwhelm even the savviest of consumers. But armed with the right knowledge, you’ll be able to confidently choose the better program for your specific needs.

Merri Adams and Mike Sarthou — top SBA 504 loan experts with San Diego-based lender CDC Small Business Finance — break down the key differences between each loan type. They also offers insights on common situations when they’re best deployed.

CDC, the nation’s leader in SBA 504 loans, offers a wide selection of loan options for businesses of all stages with varying needs. See which one is the better fit for you:

What are the key differences between the SBA 504 and 7a?

First, the basics. An SBA 504 loan is commercial real estate financing for owner-occupied properties. These loans require only a 10 percent down payment by the small business owner. And funding amounts range $125,000 to $20 million.

On the other hand, SBA 7a loans can be used to buy a business or obtain working capital. The maximum loan amount is $5 million.

A 504 loan’s interest rate is fixed, and no outside collateral is required. Also, fees are lower compared to a 7a loan. Currently, 504 loans are amortized over 20 years, Adams said. But a 25-year option will be available April 2018.

The interest rate on a 7A, however, can be adjustable and tied to the prime rate. Collateral is required, at 90 percent. These loans are amortized over 25 years.

Can you share some history and specifics on each program?

The SBA 504 loan program was designed for small businesses to finance commercial real estate or large equipment for use in the business operations, Sarthou said.

The 7a loan program was originally designed for higher-risk loans for things like the purchase or starting of a business and working capital. This loan type can also be used to finance furniture, fixtures and leasehold improvements.

What’s a common situation where an SBA 504 loan is the better choice?

When there are multiple partners where one has more assets and equity in their home than the other. Again, an SBA 504 loan does not take a lien on any outside collateral or a home whereas a 7A loan does. If a 7a loan is used in this scenario, “it becomes unfair to the more asset-rich partner,” Adams said.

What about fees and down payments?

Fees on 7a loans tend to rise with the project size, Sarthou adds. For example, the guarantee fee for a loan over $700,000 is 3.5 percent — for a project up to $1 million. When the project exceeds $1 million, the rate jumps to 3.75 percent.

However with the 504 loan, the fees involved stay flat as a percentage whenever the loan amount increases. On a $1.25 million commercial real estate project, the fees for a 7a loan can top $27,891, while the fees for a 504 loan are just over $13,306.

Also, the down payment required for the $1.25 million 7a loan would be $187,500 while the down payment for the 504 loan would be $125,000. Thus, there’d be a $77,085 out-of-pocket savings to the borrower if the property was financed with a 504 loan, Sarthou said.

Why is the 504 vs. 7a question such a common one among prospective borrowers?

Most borrowers go to their bank of account first when looking to finance real estate. So, oftentimes clients may only get the 7a option. Once they start to do some research, they’ll usually find out about the 504 program. “My guess is they are trying to get educated about their options,” Sarthou said.

In what situation would a 7a loan be a better fit?

When a business purchase is being combined with a real estate purchase and there is a need to borrow working capital. “All of these can be rolled into one SBA 7A loan,” Adams said. SBA guidelines forbid using 504 loans to finance a business purchase or for working capital.

Can you use a 7a loan to buy commercial real estate?

Yes, this is possible. However, the 7a option would be more expensive as it relates to the SBA guarantee and SBA fees, Adams said. Also, banks are not supposed to finance those fees with the loan proceeds. So, there is a much more expensive up-front cost with 7a loans.

Here’s a hypothetical situation: For projects where the property price combined with tenant improvement exceeds $775,000 — the dollar-cost difference is dramatic. In this case, the fee for the 504 loan would be 1.2 percent of the total loan compared to 2.9 percent for the 7a loan.

What’s more, if the 7a loan is financed at 90 percent LTV (loan to value), there is usually a lien on the home, the business (UCC), or both. SBA 504 loans do not require any liens on personal residences.

Can you clear up any top misconceptions about the SBA 504 program?

Borrowers tend to think 504 loans are more complicated and harder to qualify for compared to 7a loans. Also, they often view the 504 loan prepayment penalty as onerous.

Those are all misconceptions, Adams said. First, the lending process for a 504 loan is “very similar” to that of a bank loan’s, Adams said. And it may actually take longer for a 7a applicant to be approved since outside collateral is required by the program. That’s not required from 504 borrowers.

Lastly, the prepayment penalty for 504 loans is actually less expensive than the 7a in fees and the prepayment amount. The exception: when the 504 borrower prepays in a year’s time.

What is the most common question or concern you get from borrowers regarding the 504 loan?

Borrowers are typically concerned that the process will be long and difficult. Why do they think this? Because they will need approval from the bank, the CDC and the SBA, Sarthou said.

“I assure them if they provide a complete financial package that we will be able to meet any reasonable deadline they may have and the timing will be no different if the decided to go with a conventional loan or a 7a loan,” he added.

Borrowers also tend to worry that SBA may not approve their requests. Sarthou says in his two decades of working on 504 transactions, the SBA has approved all but two requests submitted. Both of these declined requests, Sarthou added, were a result of a borrower not disclosing information that was necessary for approval.

CDC Small Business Finance offers several loan options for business owners who want to grow their operations and are planning for their long-term needs. Want to learn more about the SBA 504 and 7a loans and which is the better fit? See this easy-to-follow chart.

More on Merri Adams: A commercial real estate financing expert with 28 years of experience, Adams is focused on providing SBA financing to small businesses in San Diego County. Prior to joining CDC Small Business Finance in 2013, Adams owned her own commercial real estate loan brokerage firm for eight years. Before that, she worked for several banks, including Citibank of California, 1st Nationwide Bank and Wells Fargo.  Contact Adams at (619) 243-8665 or Learn more about her background in small business lending. And connect with her on LinkedIn.

More on Mike Sarthou: Sarthou is a senior commercial loan offer at CDC Small Business Finance with more than 20 years of experience as an SBA loan expert.  Contact Sarthou at (619) 243-8608 or Learn more about his background in small business lending here. And connect with him on LinkedIn.