The Difference Between SBA 7a and SBA 504 Loans

Small business owners have a variety of options to choose from when they’re looking for additional funds. This can be a good thing…but it can also be overwhelming. Two of the most popular small business loans are SBA 7a and SBA 504. 

Though these products may seem similar on the surface, their nuances will help you determine which is right for your business based on your goals, timeline and the amount you’re looking to borrow.

The Low Down on SBA 7a

SBA 7a could be the right loan product for you if you plan to purchase an existing business; access working capital; refinance business debt; execute tenant improvements; or purchase furniture, fixtures or supplies. 

Here are a few facts to keep in mind with SBA 7a:

• The maximum loan amount for an SBA 7a loan is $5 million. 
• Interest rates tend to be adjustable, though you can find fixed. These rates are typically maxed at prime +2.75%. Loans under $50,000 can have higher rates, while an additional 0.25% can be charged to any loan portion above $1 million. 
• SBA 7a loans amortize over 25 years for real estate, 10 years for equipment, or five to seven years for working capital. 
• Collateral, including the project’s assets and/or personal guarantees from a principal owner, is required at 90% loan-to-value. 
• Business owners looking to obtain an SBA 7a loan must have a “satisfactory” FICO SBSS (Small Business Scoring Service) score, which is essentially a credit score for your small business. While every lender is different, most consider a minimum score of 160 – on a range from 0 to 300 – to be satisfactory.

The 411 on SBA 504

The SBA 504 loan program lets small businesses finance the purchase of land, commercial real estate, ground-up commercial real estate construction or large equipment that will be used within their business operation. 

If you think an SBA 504 might be right for you, keep in mind that:

• The maximum loan amount for SBA 504 loans ranges from $5 million to $5.5 million, based on the lender and type of business. 
• The interest rate is fixed and typically below market. 
• SBA 504 loans will amortize over 20 to 25 years for real estate and 10 years for equipment. 
• A 10% equity contribution is required from the small business owner. A bank or credit union will typically supply 50% of the SBA 504 financing, with a Certified Development Company (CDC) that is licensed by the Small Business Administration providing the balance.

The Big Differences

How much skin you and your principal partners are willing to have in the game is one consideration that may sway you in favor of SBA 504. No collateral is required for this loan (aside from the project itself), while 7a can take a lien on outside collateral, including a home. 

This can understandably become an issue for many small business owners, particularly if multiple partners are involved and one partner has more assets and/or equity than the others. The stakes can be high in this instance, which gives the edge to SBA 504.

Fees associated with an SBA 7a loan are also tied to the project size, which means the larger the project value, the larger the fees. There are no SBA fees on 7a loans under $150,000, but the fees then increase from 3% on $150,000 to $700,000, to 3.5% on $700,000 to $1 million, to +3.75% on any portion above $1 million. The SBA 504 loan has a fixed percentage fee that doesn’t change if the loan amount increases. Naturally, your fixed percentage will result in a larger fee if you’ve increased your loan amount, but you can avoid the fee scale sticker shock that can come with SBA 7a loans.

On the surface, both loans appear to have a 10% down payment requirement, but this isn’t entirely accurate. The SBA 504 loan requires 10% down, though there is a caveat. Start-up and special-purpose properties may have to make an additional contribution that can add another 10% (for a total of 20%) down. SBA 7a, meanwhile, has a down payment requirement that starts at 10%. It can often be higher, depending on the lender. Small business owners looking to preserve capital may want to consider the 504 product for this reason.  

Now, we’re definitely not hating on SBA 7a. If you want to combine a business purchase with a real estate purchase and throw in some working capital, SBA 7a may be your option. That’s because 504 loans can’t be used to finance a business purchase, nor can they be used for working capital. 

Keep in mind, however, that a 7a loan can oftentimes take longer to get approved since that outside collateral is required. There is also a pre-payment penalty for SBA 7a loans with maturities of 15 years or more if they’re pre-paid during the first three years. It works out to a 1% penalty in the third year, 3% fee in the second year and 5% fee if it’s paid off the first year. You can’t avoid pre-payment penalties with an SBA 504, but these fees are lower. They start at 3% if you pay off your loan in one year, then decrease by an annual increment of 0.30% until the fee goes away at Year 11. 

One last thing to keep in mind is that SBA 504 is largely viewed as an economic development program. That means it’s big on business growth and job creation. Thus, there may be a job creation requirement depending on the amount of funds received by the small business. This is something to discuss during the application process so you, your small business partners and your lenders have clear expectations from the get-go.

There are many requirements, terms, fees and restrictions to consider when you’re a small business owner looking for financing. Though SBA 504 and SBA 7a can be great programs, it’s worth comparing the two – especially when it comes to these loans’ functions and limitations. 

Whichever SBA loan you go with, we know it can be difficult to keep track of requirements, restrictions and all the paperwork associated with these loan applications. Let Rabbet ease this burden by providing a one-stop location for all your application essentials. See how Rabbet can help, request a demo today.