If you’ve decided that getting an SBA loan is the best way for you to secure business financing, then you’ve probably heard of SBA 504 and SBA 7(a) loans.
In this guide, we’ll break down both loans and compare them so you can determine which kind of SBA loan is best for your business.
SBA 504 vs SBA 7(a) Loan
Interest Rates
The interest rate on SBA 504 loans is fixed, whereas most SBA 7(a) loans have a variable interest rate.
In both cases, the interest rate you obtain is determined by a range of factors, including credit risk, market conditions, your lender, and more.
An SBA 7(a) loan’s maximum interest rate is determined by the loan’s size. A loan of $50,000 or less has a 15% maximum, whereas a loan of $350,000 or more has a 11.5% maximum. The only kind of SBA 7(a) loan that doesn’t have an interest rate maximum is the 7(a) Export Working Capital Program (EWCP) loan.
As of February 2024, the average interest rate on an SBA 7(a) loan is 10.75%-13.25%, while the average interest rate on an SBA 504 loan is 5.87%-6%.
If you’re looking to get a lower rate on either type of loan, consider making a larger down payment (more than 10%) or offering up more collateral.
Terms
The term on an SBA 504 loan can be 10-25 years. Specifically, if the loan is for real estate, the term can extend to 20-25 years, whereas loans for equipment have a 10-year term.
The term on an SBA 7(a) loan is determined by its purpose. If it’s for real estate, the term can be up to 25 years. Loans for business acquisition or equipment can have a term of 10 years or less, whereas loans for working capital have a term of 5-7 years.
If it’s a mixed-use loan, the lender will consider a variety of factors before deciding on a term.
Loan Use
You can use an SBA 504 loan to purchase existing buildings or land, or you can use the funds to construct a new facility. The funds can also cover soft-cost development fees, including architectural design and engineering fees, legal fees, repair and maintenance costs, insurance, and marketing costs.
Additionally, an SBA 504 loan can be used to purchase new equipment, including AI-supported equipment or machinery that’s part of the manufacturing process.
Lastly, the funds from an SBA 504 loan can be used to improve existing facilities, land, utilities, parking lots, streets, and landscaping.
You cannot use an SBA 504 loan to cover working capital expenses, nor can it be used to pay for inventory. Additionally, the funds can’t be used for consolidating, repaying, or refinancing debt, nor can they be used for speculation or investment in rental real estate.
Like an SBA 504, an SBA 7(a) loan can be used to purchase or develop existing buildings, as well as purchase new equipment. But unlike a 504, a 7(a) can be used to refinance existing business debt, cover working capital expenses, and purchase inventory.
Also, a 7(a) loan can be used to expand, acquire, or start a business, whereas a 504 loan is mainly for purposes related to real estate.
An SBA 7(a) loan cannot be used to purchase land, nor can it be used to pay delinquent state or federal withholding taxes.
You can review all of the SBA loan requirements for more details about what’s needed to qualify.
Loan Sizes
You can secure $50,000 to $5.5 million in funds from an SBA 504 loan. However, if you’re undertaking certain energy projects, you can get up to $5.5 million per project, with the maximum being $16.5 million in borrowed funds for three projects.
Likewise, you can secure up to $5 million in funds with most SBA 7(a) loans; 7(a) Small, SBA Express, and Export Express loans are exceptions with $500,000 maximums.
In both cases, the size of the loan you get is based on a variety of factors, including your credit score and history, debt-to-income ratio, financial profile, collateral, and down payment.
Loan Structures
An SBA 504 loan has three distinct parts, so it’s best to understand the structure of these loans before you apply for one.
Most SBA 504 loans are structured according to the “50-40-10 model”. This means that when you get an SBA 504 loan, 50% of the funds are a bank loan, 40% come from a Certified Development Company (CDC), and 10% is the down payment you’re required to put up.
But if you’re running a business that’s been operating for less than two years, or if it’s a “special purpose property,” your loan structure will be 50-35-15, meaning 15% of the funds will be your down payment. And if your business is new AND a special purpose property, the loan structure will be 50-30-20.
It’s important to note that special purpose property is a property that can’t be converted without large capital investment because it’s designed for limited use, such as churches, nursing homes, gas stations, museums, and amusement parks.
Regarding structure, SBA 7(a) loans are different from SBA 504 loans in that most of the funds are guaranteed by the SBA.
Specifically, if you get a Standard SBA 7(a) loan of $150,000 or less, 85% of it will be guaranteed by the SBA; 75% will be guaranteed if it’s larger than $150,000. And if it’s an Export Express, EWCP, or International Trade loan, 90% of the funds provided will be guaranteed by the SBA.
SBA 7(a) Express loans have the lowest guarantee at just 50%.
Program Requirements
To qualify for an SBA 504 loan, you’ll need to occupy at least 51% of the existing building you intend to purchase or 60% if you’ll be using the funds to construct a new building. If you’re using the loan to purchase new equipment, the equipment must have at least 10 years of economic life.
Additionally, your business has to make a profit, and your tangible net worth can’t be higher than $15 million. Lastly, your average net income over the last two years cannot have exceeded $5 million (after federal income taxes).
An SBA 7(a) loan that’s used for real estate development has the same building occupancy requirements as a 504 loan, but the remaining requirements are easier to meet, even if you have bad credit and limited business history. Just make sure your business meets the SBA’s small business definition before applying.
In addition to the requirements above, you’ll also need to provide a comprehensive business plan, appraised collateral, and a down payment to secure either a 504 or a 7(a) loan.
Business Size
So long as your business isn’t worth more than $15 million, and you haven’t made more than $5 in net profit after taxes over the last two years, you can apply for an SBA 504 loan.
An SBA 7(a) loan is more tricky in that business size eligibility is largely determined by the industry you’re operating in.
Also, you can’t do more than $33.5 million in annual sales if you’re in retail, service, or agriculture. Finally, you can’t have more than 1,000 employees if you’re in wholesaling or manufacturing.
Down Payment
The down payment required for an SBA 504 loan is 10% of the loan’s value, but you can put down as much as 20%.
For a 7(a) loan, a down payment is only required if the loan is larger than $500,000 or the funds will be used to finance a startup or business acquisition.
But in some cases, businesses that want to take out a sizable 7(a) loan are required to put up as much as 30% as a down payment. For example, if your business’s credit is poor, or if you haven’t been in business a long time, you may be required to put up a larger down payment.
Collateral
To take out an SBA 504 loan, you’ll need to put up collateral. SBA-backed lenders require collateral so they don’t take a total loss in the event of a borrower defaulting.
In the case of 504 loans, generally it’s the assets or property purchased with the loaned funds that’s put up as collateral. The reason for this is because, in the event of default, the lender can sell the purchased assets or property to reduce their loss from the bad loan.
Additionally, you’ll have to sign a personal guarantee, wherein you agree that your personal assets and property can be seized and sold if you default.
An SBA 7(a) loan only requires collateral if it’s larger than $50,000. 7(a) loans that do require collateral can be backed by the assets or property acquired by the funds, or the borrower may have to put up their personal residence as collateral—unless the lender can justify why this isn’t necessary.
If the borrower can avoid putting up their residence as collateral, they may still have to sign a personal guarantee, wherein they pledge to forfeit other valuable assets in the event of default.
Fees
The fees on a 504 loan are factored in, meaning you won’t have to pay anything out of pocket to secure this kind of loan. In all cases, there’s a servicing fee and a legal review fee, which can be negotiated by you and the lender you choose.
The fees on a 7(a) loan can be factored in or they can be paid separately. And just like the 504, the amount you pay in fees on a 7(a) loan is mainly determined by the loan’s size.
Additionally, if you secure more than $1 million in funding with a 7(a) loan, you’ll have to pay a 0.25% fee on every dollar over $1 million.
Average Funding Timeline
How long it takes to get either loan is based on a variety of factors, but in general it takes 60-90 days to get the funds from an SBA 504 or 7(a) loan in your business bank account. If you need funds quicker than that, consider an SBA Express Loan which can take just 5-30 days.
Usually, it only takes the SBA a few days to a couple weeks to approve a request, which means the lender’s approval process is what takes the most time. Therefore, choosing the right lender is essential if you want to expedite the process. By using a broker like Llama Loan – you can speed up the process and get access to your financing much quicker.
If you have a good credit score and history, a detailed plan, a healthy financial situation, and all the necessary materials when you apply for the loan, it should only take a couple months or less to secure the funds you need.
When Is an SBA 504 Loan Better Than a 7(a) Loan?
If your business is looking to purchase or develop a large commercial property, then choosing an SBA 504 loan over a 7(a) is a smart move.
With this loan, you’ll be able to secure the funds needed to complete the project, and the amount you’ll pay in interest will be lower than what you’d pay on a 7(a) loan because the rate will be fixed.
Just be sure your business meets the loan requirements before you apply. Specifically, make sure you can put down 10% of the loan’s value as a down payment, and confirm you’ll meet the SBA’s occupancy criteria for 504 loans.
When Is a 7(a) Loan Better Than a 504 Loan?
It’s best to go with an SBA 7(a) loan over a 504 loan if you need funds to cover inventory costs, working capital expenses, or debt obligations. It’ll be even better if your loan is less than $50,000, as then you won’t have to put up collateral or a sizable down payment.
Additionally, these loans are relatively easy to acquire, even if you have bad credit or limited business history. Plus, consistently making repayments on time will help you build credit.
But before you apply for one of these loans, be aware that the interest rates on them are often variable, so you may pay a lot in interest before the loan is completely paid off.
Can You Purchase Commercial Real Estate With a 7(a) Loan?
Yes, an SBA 7(a) loan can be used to purchase most kinds of real estate. That said, most businesses that need a loan for purchases related to real estate choose an SBA 504 over a 7(a), mainly because the interest rates on 504 loans are lower.
Also, you can’t purchase land with a 7(a) loan, so this is only a viable option for businesses that want to purchase an existing building.
However, if you’re only looking to purchase a cheap property, or if you’re just doing renovations, a 7(a) loan may be the best option. For example, if you need less than $50,000, and you can pay it back quickly, a 7(a) loan may be better, as you won’t have to put up collateral or meet job creation and community development goals.
Final Thoughts
SBA 504 and 7(a) loans are great options for businesses that need financing, but which loan is best for your business is largely determined by how you plan to use the funds.
If you need a sizable loan with a longer term and lower interest rate to purchase real estate or equipment, consider a 504 loan. If you need a small loan with a shorter term, and you need it quickly, to cover working capital expenses, inventory costs, or debt obligations, a 7(a) loan may be the better option.
Key Takeaways
