SBA 7(a) Loan FAQ
At 7aSavvy we want to match you with the best lender for your loan, but we also want to help you understand 7(a) loans. We know that there’s a lot to learn, and it can all be a bit overwhelming! This page has answers to many of the common questions borrowers have about 7(a) loans.
For a broad background on 7(a) loans, you can check out our 7(a) Loans, 7(a) Lenders, and 7(a) Interest Rates pages.
Uses
7(a) loans can be used in a variety of ways, with valid uses of proceeds including:
– Real estate purchase
– Business purchase
– Construction
– Equipment purchase
– Debt refinance
7(a) loans cannot be used for real estate investment, either commercial (e.g. a strip mall) or residential (e.g. a multifamily/apartment building). If a 7(a) loan is used to purchase real estate, it must be with the primary goal of operating a business on the premises. However, the owner may still rent out up to 49% of the property.
7(a) loans can be used for almost any kind of for-profit business. Some common uses of 7(a) loans include:
– Retail
– Restaurants
– Hotels/Motels/B&Bs
– Gas Stations
– Convenience Stores
– Storage Facilities
– Office Buildings
– Car Washes
Eligibility
SBA 7(a) loans are available for almost all for-profit small businesses in the United States, with exceptions including investment businesses (any business that primarily makes their money from rent – apartment buildings, strip malls, etc.), private member clubs, banks, gambling businesses, and more.
SBA 7(a) loans are available to all U.S. citizen or permanent resident borrowers, other than those who have been convicted of some (but not all) felonies, those currently charged with a felony or incarcerated, and those who have caused a financial loss to the federal government (typically through a default on a past government-backed loan). However, each lender also has their own personal eligibility criteria.
Terms
SBA 7(a) loans have a maximum loan amount of $5,000,000.
The minimum down payment of SBA 7(a) loans is 10%. This is also the typical down payment. However, a lender may require a higher down payment.
However, it can sometimes be possible for the borrower to pay less than 10%. Most common in the case of business purchase loans, this can be done through a “seller note” (also known as a “seller carry back”), where the seller accepts part (or all) of the purchase price as a series of deferred payments. This effectively converts part (or all) of the down payment into a loan from the seller to the borrower, and as such allows it to be smaller than it could be otherwise. Seller notes are a valuable tool to help make marginal loans work.
SBA 7(a) interest rates are based on the prime rate, with 7(a) interest rates typically ranging from prime + 1 and prime + 3. The current prime rate is 7.5%, meaning the current average SBA 7(a) loan rate is 9.5%. However, this can depend on the size of the loan and whether the rate is fixed or variable, among other factors. For more information, see our SBA 7(a) Interest Rates page.
SBA 7(a) loans have a maximum term of 25 years for loans involving real estate, and a maximum term of 10 years for loans not involving real estate. These are also the typical terms, as a longer loan term means lower loan payments.
If a loan has multiple uses of proceeds that mix real estate and non-real estate uses (for example, real estate purchase and business purchase), the maximum (and typical) term is 25 years if >50% of the use of proceeds are for the real estate. If 50% or less is for the real estate, the loan will have a blended term (in between 10 and 25 years) determined by the proportion of the loan used for each purpose.
Most small business loans are required by the lender to be “fully collateralized”, i.e. have a collateral value equal to or greater than the value of the loan, usually including a discount rate. For example, at a common 20% discount rate on an $800,000 loan, the collateral must have a market value of $1,000,000 to be fully collateralized.
For SBA 7(a) loans, full collateralization is required if possible, which is usually only the case for loans involving real estate that provides most or all of the needed collateral value. If the loan doesn’t involve real estate – or if the value of the real estate isn’t enough – other common forms of collateral may be used, such as a life insurance policy taken out on the borrower or a lien on the borrower’s home.
If full collateralization isn’t possible, a lower level of collateral is usually acceptable. This makes SBA 7(a) loans an ideal option for uses of loan proceeds with little inherent collateral, such as business startup or business purchase loans.
A personal guarantee for a small business loan means the borrower(s) will be personally financially responsible for the loan should the business not be able to make the loan payments. Most small business loans require a personal guarantee from the borrower(s), and this includes SBA 7(a) loans.
For SBA 7(a) loans, all borrowers with a business ownership share above 20% are required to give personal guarantees. Additionally, anybody other than the owner (a manager, for example) with full control over the business is typically also required by the lender to give a personal guarantee.
The amortization of a small business loan is the period over which the loan payments are spread. SBA 7(a) loans are fully amortized, meaning their term and amortization period are the same. This means they’re fully paid off by regular, same-sized (other than the effects of interest rate changes) payments, with no balloon payment at the end. This is a notable advantage to 7(a) loans (and other government guaranteed loans, like SBA 504 and USDA B&I loans), as it makes the loan more secure and consistent for the borrower.
SBA 7(a) loans have prepayment penalty periods of three years, with penalties decreasing from 5% the first year, to 3% the second year, and 1% the third year. This period is notably short, years shorter than the average prepayment penalty period for a conventional loan. This means that SBA 7(a) loans offer borrowers unbeatable flexibility, allowing for penalty-free refinances from year four of the loan term on. This ability can then be used to take advantage of changing rates, provide capital for business growth, and more.
Loan Process
The SBA 7(a) loan process can be broken down into 16 steps:
Step 1: Finding a Lender
Step 2: Initial Consultation with Lender
Step 3: Initial Document Request
Step 4: Initial Document Gathering and Preparation
Step 5: Initial Document Submission
Step 6: Preliminary Underwriting
Step 7: Pre-Qualification
Step 8: Full Underwriting
Step 9: Loan Approval/Commitment Letter
Step 10: Deposits
Step 11: Third-Party Reports
Step 12: Closing Document Request
Step 13: Closing Document Gathering and Preparation
Step 14: Closing Document Submission
Step 15: Review and Approval of Closing Documents
Step 16: Loan Closing and Disbursement
For a more in-depth look at the SBA 7(a) loan process, see our page The SBA 7(a) Loan Process.
The SBA 7(a) loan process can be expected to take between 45-90 days for most loans. This can vary, however, and how long a particular loan takes depends on a few factors, including the size and complexity of the loan and how quickly the borrower provides requested documents. For a more in-depth look at how long the SBA 7(a) loan process takes, see our page How Long Does the SBA 7(a) Loan Process Take?
The SBA 7(a) loan process involves many documents that the borrower must prepare and send to the lender, including financial statements, tax forms, licenses, insurance policies, and more. These documents are usually requested in two sets: the initial document request and the closing document request.
The initial loan documents offer a comprehensive view of the borrower and the business’s operations, financial health, and legal standing. These documents are foundational, as they will form the basis of the lender’s evaluation of the loan.
The loan closing documents give the lender assurance that the business will be fully operational, licensed, and insured, as well as that the loan is eligible for an SBA guarantee.
Exactly what documents the lender requests varies based on the borrower, business, and loan. For a more in-depth look at the documents needed for the SBA 7(a) loan process, see our page What Documents Are Needed for an SBA 7(a) Loan?
Comparisons
Due to the lower risk of 7(a) loans, lenders are more willing to give them out. This often makes them more attainable, and on better terms, than conventional loans.
7(a) loans are more widely available, more flexible, and more easily attainable than 504 or B&I loans. 504 loans, also offered by the SBA, actually require two loans and have a much longer prepayment penalty period, making refinancing difficult. B&I loans, offered by the USDA, are only available to those in rural areas. Due to those and other drawbacks, 7(a) loans are much more popular and offered by far more lenders than the other two, making them the easy choice.
Cash Flow
Cash flow is a term used in the commercial loan industry. In the case of SBA 7(a) loans, it refers to a business’s net income plus depreciation, interest, and rent costs. These extra values, which can be found on a business’s tax form, are added back to the business’s income to give a more complete idea of the size of loan the business can pay back. For more information on cash flow, see our page SBA 7(a) Loans: Cash Flow.
Generally, a business (depending on the purpose of the loan, either the business being purchased or the business of the person getting the loan) must have at least enough cash flow to pay back the loan, plus a little extra. The most common metric for calculating this is the cash flow ratio, found by dividing the annual cash flow by the annual loan payment. The target cash flow ratio of most banks is 1.2.
However, this is not a hard and fast rule, as a cash flow ratio below 1.2 can still work. This is especially true if the loan proceeds are going toward buying a business. A business may be sold to an owner who will be better at running it, raising cash flow, or who will cut costs, raising the cash flow ratio.
Even if the loan is being used for something other than a business purchase, though, a lower cash flow ratio can still work. It all depends on finding the right lender – and luckily, 7aSavvy can help.
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