Many small business owners think of SBA loans when they contemplate borrowing to fuel growth, expand, or finance some other business initiative. Before you apply, there are a few things you need to know about an SBA loan. The first thing you need to know is that the SBA isn’t actually a lender—most SBA loans will come from your local bank and are guaranteed by the SBA. The guarantee is designed to make it easier for the bank to approve a loan to a borrower whose credit worthiness might fall just below the normal qualifying criteria at the bank.
There are also a number of different SBA loan types intended for different business purposes. The most common SBA loan types are:
- The 7(a) Loan: The most popular and flexible SBA loan product
- The CDC 504 Loan: A popular loan used to finance fixed assets like equipment or real estate
- The SBA Microloan Program: This loan program is designed for very small loans (under $50,000) for new and growing businesses
- The Disaster Loan Program: A loan designed to help business owners recover from damage or loss caused by a natural disaster
How SBA loans work
Although the SBA (U.S. Small Business Administration) isn’t a lender, it has guaranteed millions of small business loans since it was established in 1953. SBA loans are offered by participating banks, credit unions, and a few specially-licensed non-bank lenders. The SBA loan guarantee program was created to encourage lenders to work with more small businesses that might otherwise struggle to access capital. The guarantee programs adhere to specific lending terms, interest rate caps, and other criteria outlined by the SBA.
Because a small business loan is considered a higher-risk loan, to reduce that risk to the lender, the SBA will frequently guarantee 50% to 85% of an eligible loan (within their 7(a) loan program, for example). In effect, sharing the potential risk with the lender, which enables more small business borrowers to access capital from traditional lending sources through the SBA Loan Guarantee Program.
Because the SBA doesn’t act as a direct lender, it’s the banks and other participating lenders who decide whether or not to approve a loan application. Upon loan approval, application is made to the SBA for the guarantee.
To learn more about how to apply for an SBA-guaranteed loan, please visit the SBA website.
SBA loan options
The SBA offers several different guarantee programs—here are a few of the most popular:
The 7(a) Loan
Probably the most popular loan program is the 7(a) loan. This guarantee program is designed to fit a broad range of financing needs and is the option of choice for many small businesses—with some restrictions. Some of the basic uses of an SBA 7(a) loan could include:
- Long-term working capital to pay operational expenses, accounts payable, or to purchase inventory
- Short-term working capital, including seasonal financing, contract performance, construction financing, and exporting
- Funds for purchasing equipment, machinery, furniture, fixtures, supplies, or materials
- Real estate, including land and buildings
- New building construction or renovation on an existing building
- Funds to establish a new business, contribute to the purchase of an existing business, or expand an existing business
SBA loan programs do have restrictions. For example, funds guaranteed by the SBA can’t be used for investing or purchasing a building that will be leased to another business. They also can’t be used to reimburse a business owner for money previously invested in the business by the owner or to repay money owed to the government.
Is your business eligible for a 7(a) loan?
If you operate a small business in the United States or any of its territories, have some capital of your own to invest in your business, and are current with all debt payments to the U.S. government (including your income taxes), you may be eligible for an SBA loan—unless your business falls into one of the ineligible businesses identified by the SBA:
- Businesses engaged in the business of lending, such as banks, finance companies, payday lending, some leasing companies, and factors.
- Businesses owned by developers and landlords that do not occupy the assets acquired or improved with the loan proceeds (except when the property is leased to the business at zero profit for the property owners)
- Life insurance companies
- Businesses located in a foreign country (businesses in the U.S. owned by aliens may qualify)
- Businesses engaged in pyramid sale distribution plans, where a participants primary incentive is based on the sales made by an ever-increasing number of participants
- Businesses deriving more than one-third of gross annual revenue from legal gambling activities
- Businesses engaged in any illegal activity
- Private clubs and businesses that limit the number of memberships for reasons other than capacity
- Government-owned entities
- Businesses principally engaged in teaching, instructing, counseling, or indoctrinating religion or religious beliefs, whether in a religious or secular setting
- Consumer and marketing cooperatives
- Loan packagers earning more than one third of their gross annual revenue from packaging SBA loans
- Businesses in which the lender or CDC, or any of its associates owns an equity interest
- Businesses that present live performances of an indecent sexual nature or derive directly or indirectly more than 2.5 percent of gross revenue through the sale of products or services, or the presentation of any depictions or displays of an indecent sexual nature
- Businesses primarily engaged in political or lobbying activities
- Speculative businesses (such as oil exploration)
The interest rate you pay is negotiated between you and the lender—subject to SBA minimums and caps. Both fixed and variable rates are available and subject to an allowable spread based upon one of the following base rates:
- The prime rate published in a daily national newspaper
- The London InterBank one month prime, plus 3%
- The SBA peg rate
Even though lenders are allowed to add a spread to the base rate, the maximum spread can be no more than 2.5% on loans with maturities shorter than seven years and no more than 2.75% on loans with maturities seven years or longer.
The CDC 504 loan program
The CDC 504 loan program is designed to provide financing for major fixed assets like equipment and real estate. The following three categories, determine maximum loan amounts.
- Job Creation: The maximum loan amount associated with a job creation or community development goal is $5 million. You business must create one job for every $65,000 borrowed. Small manufacturers must create one job for every $100,000 borrowed.
- Public Policy: The maximum loan amount associated with a public policy goal is $5 million or $5.5 million for small manufacturing, energy reduction, or alternative fuels. Public policy goals include business district revitalization, minority business development, expansion of veteran-owned business and women-owned business, to name a few.
- Small Manufacturing: The maximum loan amount for small manufacturers is $4 million. To qualify for a $4 million 504 loan, your business must meet the definition of a small manufacturer and accomplish one of the following:
- Create or retain at least one job per $100,000 guaranteed by the SBA
- Improve the economy of the locality or achieve one or more public policy goals
The assets being financed are typically used for collateral along with a personal guarantee of the principle owner(s). Loan terms of 10 and 20 years are available, with interest rates pegged to an increment above the current market rate for 5-year and 10-year U.S. Treasury issues. Fees totaling approximately three percent may be financed with the loan.
The SBA Microloan Program
The SBA Microloan Program is designed for very small loans that are available for newly established or growing small businesses. The SBA makes these funds available through nonprofit community-based lenders. The maximum microloan at the SBA is $50,000 and application and credit decisions are made at the local level.
Microloans can be used for:
- Working capital
- Inventory or supplies
- Furniture or fixtures
- Machinery or equipment
Like a 7(a) loan, loan proceeds can’t be used to pay existing debts. They also may not be used to purchase real estate.
Repayment terms vary according to several factors that include the amount of the loan, what the loan proceeds will be used for, the requirements of the intermediary lender, and the needs of the borrower. The maximum allowable repayment term is six years.
The interest rates vary, depending upon the lender and the costs to the lender from the U.S. Treasury. Rates are normally between 8 percent and 13 percent.
SBA Economic Injury Disaster Loan Program
The Economic Injury Disaster Loan (EIDL) Program is designed to provide low-interest loans to businesses of all sizes, private non-profit organizations, homeowners, and renters to repair or replace real estate, personal property, machinery, or equipment that was damaged or destroyed resulting from a declared disaster.
You can apply online or in-person for SBA disaster assistance. The SBA suggests the online application is the fastest way to receive a decision about your eligibility, but you also have the option of submitting an application by mail.
SBA loan guarantee programs may not be the biggest source of funds for small business owners, but they do fill an important niche within the small business lending landscape for those that qualify. Depending upon loan purpose, qualification criteria, and how quickly a business needs to access funds, the SBA may be a good option for many small business owners.
Borrowers should be prepared, however, to meet many of the same criteria required for a traditional loan approval at the bank including some additional requirements set in place by the SBA. And, although recent efforts by the SBA to streamline the application process have reduced the time it takes for many business owners, qualified potential borrowers should expect a weeks- or sometimes even months-long process to apply, gain approval, and access funds. Learn more about the SBA Economic Injury Disaster Loan Program in our guide.
For small business owners who need their funds faster and don’t have time to go through a weeks-long approval process, a loan from an online lender like OnDeck can be a good fit. Learn more about your financing options with OnDeck.