SBA 504: Good for Borrowers and Lenders

June 05, 2015

While stories abound about government programs that are wasteful and ineffective, the SBA 504 loan program is a refreshing exception that has helped thousands of small businesses. It has provided badly needed capital to borrowers while offering the credit enhancement that banks need to keep the money flowing. It allows for greater flexibility than its cousin, the SBA 7a loan, which I wrote about in an earlier posting. It doesn’t require that business assets other than the property being financed to be pledged as collateral.

The 504 loan program is designed for owner-occupied properties. Investment properties are ineligible. For existing properties, the Borrower must occupy at least 51% of the property. If the property is ground-up construction, then the Borrower must occupy at least 60% of the property.

The 504 loan program is most often used to finance commercial real estate, and is actually structured as two separate loans. Typically the bank makes a first lien mortgage for 50% of the project, and a Certified Development Corporation (CDC) makes a loan for 40% of the project as a second lien, and the Borrower will contribute 10% as their down payment. The Borrower may be required to increase their equity contribution if the business is a start-up or the property is deemed by the CDC as “Special Purpose.” The Small Business Administration backs the second lien loan with a SBA guaranteed debenture. The borrower makes two payments to service the debt: one to the bank holding the first lien, and the other to the CDC.

The terms of the first lien loan can be flexible, with the rate, term, and interest adjustment schedules negotiated between the borrower and the bank. The second lien loan will be a fixed rate loan which fully amortizes over 20 years. Since it is guaranteed, the interest rate on the second lien portion is typically lower than the first mortgage.

Banks like these loans, and are eager to make them because it allows the bank to retain a well-secured earning asset on the books and to keep a valued relationship with the customer. Customers benefit because they get access to reasonably priced capital without having to tie up assets that can be used as collateral for future financing needs.

The one serious drawback that SBA 504 has is that there is a big prepayment penalty on the second lien loan that does not go away entirely until the eleventh year. Prepayment terms on the first lien are negotiable between the borrower and the bank, and this can lessen this disadvantage.

Used in the right circumstances, SBA 504 loans can be the best choice for many borrowers. But it is worth noting that if a borrower has equity or down payment of 20% or more of the loan amount, conventional bank financing may be the way to go. Without the SBA rules in the way, we have the greatest flexibility in tailoring a credit facility that will truly meet the borrower’s needs. I have included a chart below that compares features of SBA loan programs with conventional bank loans. If your business needs financing, call me or any of our commercial lenders and we will meet with you to discuss your options.


loan type comparison (Click on the image for a downloadable PDF)

Ebook on Business Borrowing

Topics: The Corner Office

Ed Lette

Business Bank of Texas

Ed Lette is a Founder of Business Bank of Texas. Serving as a licensed CPA since 1983, Ed’s extensive experience in the banking industry has led him to become the founding president of four national bank charters including Business Bank of Texas, N.A., and the chief financial officer of five national banks during his 45 year career. Ed serves as director of the Texas Bankers Association District 4, chairman of the Executive Advisory Council to the School of Business at Texas Lutheran University, and is a life member of the Texas Association of Business.
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Guide to Business Borrowing

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