Navigating the world of business financing can be complex, especially when it comes to choosing the right loan for your specific needs. Two popular options offered by the Small Business Administration (SBA) are the 504 and 7(a) loan programs. While both are designed to support small businesses, understanding the difference between SBA 504 and SBA 7(a) Loan programs is crucial in making an informed decision.
These loans differ in purpose, structure, eligibility requirements, and more. Below is a summary of their differences.
Summary Table: Difference Between SBA 504 and SBA 7(a) Loan
| Feature | SBA 504 Loan | SBA 7(a) Loan |
|---|---|---|
| Primary Purpose | Economic development, purchase of fixed assets like real estate and equipment | Broad, including working capital, debt refinancing, and purchasing businesses |
| Loan Structure | Partnership with CDC; split between bank (50%), CDC (40%), and borrower (10%) | Provided through financial institutions with SBA backing |
| Maximum Loan Amount | $5 million | $5 million |
| Minimum Loan Amount | $120,000 | No set minimum |
| Use of Proceeds | Financing existing properties, new construction (with ownership conditions) | Working capital, purchasing fixed assets, refinancing debt |
| Eligibility | Operate in US, net worth under $15 million, average income under $5 million | Generally need a credit score of 650+, strong business history |
| Job Creation Requirement | At least one job per $75,000 lent by CDC | Not specified |
| Interest Rates and Fees | Fixed rate; fees include CDC processing and servicing fees, SBA guarantee fee | Fixed or variable rate; fees primarily include SBA guarantee fee |
| Loan Terms | 10, 20, or 25 years, depending on the use | Up to 10 years for working capital, up to 25 years for real estate |
| Collateral | Funded assets serve as collateral | May require additional collateral, depending on loan size and purpose |
Differences Between the 504 and 7(a) Loan
Both loans vary in different features such as the structure, loan amount, permissible use, loan terms, etc. A business owner will have to go for the loan that best fits the purpose the loan is meant to serve.
We will describe the factors that make up the SBA 504 and 7(a) loan programs below.
1. The difference in purpose:
The SBA 504 loan is a program with the primary aim to create or improve economic development in a community. When applying for a loan, the business owner will have to work with an approved Community Development Company.
This is a specialized loan for businesses that need financing to purchase or maintain fixed assets such as equipment, landed property, or a building. These loan aids business owners create job opportunities and adding to the growth and development of a community.
Although the SBA guarantees this loan, they are not lenders. Instead, the business owner works with a Community Development Company that the SBA approves.
On the other hand, the SBA 7(a) loan program is one of the most popular loans offered to small businesses. This loan provides business owners with working capital to maintain their business, purchase fixtures, furniture, or purchase an existing business.
2. Loan Structure and Size
The maximum amount offered to business owners going for the SBA 504 loan is $5 million, and the minimum amount is $120,000. In this loan program, the loan structure is divided into three parts. The direct lender (possibly a financial institution) offers 50% of the loan, 40% from the CDC, and the lender puts up 10% of the loan.
Although the Small Business Administration guarantees a portion of the 7(a) loan, they are not the lenders. An approved financial institution or credit union grants small businesses loans through the SBA. Depending on the project the loan will be used for, the maximum amount is $5 million.
There’s no minimum amount the SBA set under the 7(a) loan program.
Read More: What To Know About The SBA 7(a) Loans
3. Use of the Proceeds
The proceeds of the SBA 504 loan can only be used to finance currently existing properties that are 51% owned by the business owner. But when a business owner wants to construct a new building, 61% percent of the building should be owned or occupied by the business.
Also, a business owner cannot use the loan to purchase furniture, fixtures, or working capital.
Although the SBA 7(a) is the most popular loan among the other small business loan programs, it’s restricted to different uses. This loan can mainly be used as working capital, refinance business debt, purchase fixed assets for the business and retain employees.
4. Eligibility and Requirements
Not all businesses are eligible for the SBA 504 loan because the SBA has set out specific qualities a business should possess. It should be running its operations in the US for not less than two years. The business should possess a net worth of $15 million with an income of $5 million after-tax payments.
Under the SBA 504 loan, a business must create at least one job from every $75,000 the CDC lends. And in doing this, the business must ensure that the job is created in the local community.
If this goal can’t be achieved, you can endeavor to meet the community goal in development by furthering the growth of women-owned businesses.
Apart from the general qualities the SBA has set out for qualified businesses, lenders set out specific qualities for the SBA 7a loan. You’ll need to have a strong credit score of 650+ and present your business history as proof of your ability to pay back.
Also, it’s required that you must have tried to use other financial resources of the business.
5. Interest Rates and Fees
>> The SBA 504 loan:
The SBA 504 loan interest rate is one of the lowest interest rates under the SBA’s many loan programs. This program offers a fixed interest rate financing system where the borrower pays a fixed interest rate during the loan period.
There are different kinds of fees listed under the SBA 504 loan program. There’s CDC processing fee, CDC servicing few, SBA upfront guarantee fee, and the SBA annual service fee.
While the CDC is processing the loan, they charge a 1.5% fee from the borrower, known as the CDC processing fee. The CDC also charges an annual servicing fee of 0.625% -2% based on the loan balance.
On the part of the SBA, they charge 0.5% from the borrower during the process of acquiring the loan and an annual service fee of 0.368 from the borrower.
>> The SBA 7a loan:
Under the 7(a) loan, the SBA offers a fixed and variable interest rate. Also, applicants are allowed to negotiate the interest rates with the lenders. Depending on the loan size and time of maturity, most loans under this program have an interest rate of 4.5%-6.5%.
Here the SBA doesn’t attach any other fee apart from the guarantee fee. However, the SBA will charge a percentage from the portion of the loan the SBA guarantees. The reason is to ensure they pay back the money to the lenders if the borrower defaults on the loan payment.
If an applicant applies for a $150,000 loan, the SBA will charge a 2% fee on the guaranteed portion of this loan. For loans from $150,000 to $700,000, the SBA will charge a 3% fee on the guaranteed amount. And loans that are from $700,000 to $5million, the SBA will charge a 3.5% fee on the guaranteed portion of the loan.
In the end, your borrowing cost might increase because your bank might also charge you based on loan packaging and closing fee.
6. Loan Terms
The loan repayment terms under the SBA 504 program are divided into three time periods. There are the 10years, 20years, and 25years repayment terms, respectively. If you apply to use the loan to purchase business equipment, the lifespan of the equipment will determine the terms of the loan.
In the SBA 7(a) loan, the repayment time is fixed according to the loan’s use. The scenarios below will clarify this statement.
Scenario 1: If you apply for a loan that will be used for working capital, you will have to repay the loan within a total of 10years. This loan will be used to expand the business and purchase the business supplies or inventory.
Scenario 2: If the loan is used to purchase business equipment and machinery, the loan will have a 10-year repayment term. And it’s expected that the equipment or machinery will last up to the repayment time or more.
Scenario 3: For purchasing/making improvements on real estate and constructing a building, the borrower will have a 25 years repayment term.
7. Collateral
In the SBA 504 program, the borrower is not expected to provide additional collateral beyond what the fund was used to purchase. This is because the fixed assets will serve as collateral.
The CDC and the bank often request that the business owner with a solid financial history sign up as a personal guarantor. Additionally, anyone with a 20% ownership of the business can stand as a personal guarantee. This is to make sure that the risk is reduced on the side of the CDC and the bank.
Unlike the SBA 504 loan, some loans under the 7(a) program require collateral. Anyone who holds a 20% share of the business will have to sign up as a personal guarantee when applying for this loan. So if the business assets can’t cover up the loan payment, the person will stand in to pay back the loan.
More so, the financial institution will request the business owner to sign a mortgage on all properties or assets the loan will purchase. And if the assets can’t recover the loan in full, the mortgage will be placed in the owner’s personal properties or assets.
Bottom-Line
The SBA 504 and 7(a) loan programs are provided to solve peculiar business financing challenges. You can look into both loan offers and apply for one that could solve your business financing challenge.
It’s important to note that this post does not substitute a professional financial advice. As a business owner, you should consult with financial advisors or directly with the SBA for personalized guidance.
