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The Small Business Administration (SBA) offers a number of SBA loans options to small businesses based in the U.S. While there may be a variety of choices, it creates confusion regarding which loan may be the best choice, including comparing the popular SBA 504 vs. 7a loans to one another.
The SBA administered over 61,000 504 and SBA 7(a) loans worth over $44 billion in funds in 2021. SBA 7(a) loans are usually used for working capital or expansion and 504 loans are typically used for purchasing property or equipment.
SBA 7(a) Loan vs. 504 Loan - Overview
If you’d like to understand what is the difference between SBA 504 and 7(a) loans, the chart below provides a quick reference.
SBA 7(a) Loans
SBA 504 Loans
|Loan size||Up to $5 million||$5,000 to $5.5 million, depending on business|
|Type of interest rate||Variable||Fixed|
|Interest rate||Prime Rate + 2.25% up to 4.75%||Tied to the five- and 10-year U.S. Treasury notes and are typically around 3% of the amount financed|
|Loan repayment terms|
Working capital/machinery/equipment: 5-10 years
Real estate: 25 years
|10, 20, or 25 year repayment|
|Down payment||10% to 20%||10% to 20%|
|Collateral||Possibly use equity in personal and investment real estate||Assets the loan is used for, possibly a personal guarantee|
|Applicable fees||Annual service fee, guarantee fee, and bank fees||SBA, CDC, guarantee fee, and bank fees|
|Turnaround time||Five to ten business days||60 to 90 days|
|Approved loan uses|
● Working capital
● Debt consolidation
● Seasonal line of credit
● Purchasing land
● Business expansion
● Commercial real estate
● Large equipment purchases
Comparing SBA 504 vs. SBA 7(a) Loans
SBA 504 loans
What is an SBA 504 loan? The 504 loans are most often used to purchase fixed business assets and are provided through the local Certified Development Companies (CDC) licensed and approved by the SBA.
The eligibility requirements for the 504 loans differ greatly from the SBA 7(a) loans. There is a job creation and retention requirement added to this loan where the business must adhere to job creation rules within the local community. Or, another qualification is it must also support one of the public policy initiatives of the SBA, such as being female or minority-owned.
504 loans require at least a Low down payment - (10,15 or 20 percent) down payment, but some startups could be required to put down as much as 20%. While you can borrow up to $5 million, you may be eligible for a larger loan amount, depending on the lender
The fixed interest rates, which are tied to the five- and 10-year U.S. Treasury notes and are typically around 3% of the amount financed and are more attractive to many businesses because the rates are typically lower than other types of business loans. Loan terms are available in 10, 20, or 25-year terms, which gives them added flexibility for the borrower.
Collateral and credit
The terms are desirable, but an SBA 504 loan does require collateral and, in some cases, a personal guarantee. The assets you’re using the loan for is the collateral and in most cases is all that is needed. If you own more than 20% of the business then you may be required to add the personal guarantee, which lessens the risk to the lender.
Although each 504 loan lender may have its own set of credit requirements, the business will need a good to excellent credit rating to qualify. A long history of doing business is also reviewed, but it is possible for startups to be considered too.
Business use for 504 loans
One of the largest differentiators between SBA 504 loans vs. 7(a) is the business use for these loans. 504 loans can be used for commercial real estate or business expansion and modernization efforts. 504 loans can not be used for working capital or inventory, nor used for consolidating debt.
SBA 7(a) loans
What is an SBA 7(a) loan? Whereas the 504 loans might seem more restrictive, the SBA 7(a) loans are a low-interest rate alternative and can be used for a wide range of business needs.
The 7(a) loans offer borrowers up to $5 million in funding, similar to the 504 loans. However, the interest rate structure is different, with rates based on the prime rate plus up to 4.75% for 7 year + loans. Loan terms range from five years and up to 25 years, depending on the business purpose. Another positive aspect of the 7(a) loan is the quicker decision process from the SBA. Most loan decisions are made within five to ten business days, making it ideal for businesses who need funds fast.
A 7(a) loan is subject to an annual service fee, which is up to 0.55% of the total borrowed loan amount. A guarantee fee is also required, which is currently up to 3.75% for the guaranteed portion of the loan.
Another aspect to consider with 7(a) loans are the prepayment fees. The prepayment penalty ranges from 1% to 5%, depending on when the loan is prepaid.
Collateral and credit
Similar to the 504 loans, a business should have a good to excellent credit rating to be considered for a 7(a) loan. Businesses with a history of foreclosures, bankruptcies, and defaults on government-backed loans will likely have a challenging time getting approved. The business should also be prepared to discuss any negative marks on the credit report.
If the loan exceeds $350,000, the SBA requires the lender to use collateral for the loan, up to the loan amount. For loans less than $25,000 there is no collateral requirement.
Business use for 7(a) loans
One reason for the popularity of the 7(a) loans is its flexible business uses. SBA 7(a) loans are available for numerous business uses, including:
- Purchase of fixed assets, such as furniture or equipment
- Purchasing land or commercial properties
- Working capital
- Debt refinancing
- Establishing lines of credit for seasonal business
The SBA has clear exclusions for businesses ineligible for loans. This includes any business related to gambling, investing and lending, loan packaging, multi-level marketing, or if the owner is on parole. Plus the lender itself can have its own list of excluded businesses to lend to. Lastly, like a 504 loan, the business must be a for-profit to be eligible.
504 vs. SBA 7(a) Loans - Which One Fits Better To My Business
There are so many details and variations to each of the SBA loans that it may be hard to know when you should use the SBA 504 vs 7(a).
Typically, an SBA 504 is a better fit when:
- Your business needs to purchase real estate
- You don’t have outside collateral
- If prepayment is a possibility, since the prepayment penalties are less severe
- A 10% down payment works better
- You need a greater amount of funding to cover a large purchase
- A slower application process is not an obstacle
- Your business meets the job creation, retention, or policy alignment requirements
There are situations where the 7(a) loan is likely a better option for your business, including:
- You’re financing a business acquisition or working capital
- Need the funding to purchase inventory, supplies, or infuse cash flow
- The funds are used for commercial real estate
- You need less than $5 million in funding
- A faster application process works better for your business timeline
504 vs SBA 7(a) loans - Distinct Tools for Different Goals
Choosing the 504 vs. SBA 7(a) loan comes down to which one works best for your business needs. The right loan you choose to put your time and energy into is based on a few factors, including:
- Thoroughly evaluating your business needs prior to the application process.
- Not simply focusing on interest rate, but considering the payment terms, business use, and fees associated with each loan.
- Be prepared to ask questions and seek help to navigate the application process.
If you’re ready to take the next step and apply for an SBA loan, start the process here.