SBA 7(a) loans are different from conventional small business loans in many ways, and their terms have unique requirements and parameters. As such, here’s an explanation of SBA 7(a) loan terms.
Loan Amount
SBA 7(a) loans have a maximum loan amount of $5,000,000.
Down Payment
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.
It can sometimes be possible for the borrower to pay less than 10%, however. 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.
Interest Rate
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 8.5%, meaning the current average SBA 7(a) loan rate is 10.5%. However, this can depend on the size of the loan and whether the rate is fixed or variable, among other factors.
Term
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.
Collateral
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 20% discount rate on an $800,000 loan, the collateral must have a market value of $1,000,000 to be fully collateralized.
SBA 7(a) loans are a bit different. 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.
Personal Guarantee
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.
Amortization
The amortization of a small business loan is the period over which the loan payments are spread. Most conventional loans are amortized over a period longer than the loan term, which makes loan payments lower, but necessitates a loan extension or balloon payment at the end of the loan term (as it’s still not fully paid off).
SBA 7(a) loans, on the other hand, 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.
Prepayment Penalty
A prepayment penalty, included in most commercial loans, is an added cost for prepaying a loan before a certain time. There are a few different structures lenders use, but the most common one penalizes the borrower a certain percentage of the loan amount for prepaying the loan. Prepayment penalty periods are almost always shorter than the loan term, instead lasting a certain number of years before ending and allowing penalty-free repayments.
Larger prepayment penalties and longer prepayment penalty periods reduce flexibility for borrowers, and as such it’s preferable to have as light a prepayment penalty and as short a prepayment penalty period as possible.
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.
