SBA 504 Loan: What Is It and How Does It Work?

SBA 504 loans offer funding for commercial real estate or large equipment. Guaranteed by the Small Business Administration (SBA), these loans offer long repayment terms and comparatively low interest rates.

We’ll dig into how to get 504 loans and what’s required if you want to apply.

What is an SBA 504 loan?

An SBA 504 loan offers long-term, fixed-rate financing for small businesses to purchase fixed assets, such as commercial real estate or heavy machinery. There are three parts, including a low down payment made by the borrower; a loan from a certified development company (CDC) that is guaranteed by the SBA; and a loan from a bank or other lender.

We’ll break down the three parts:

• 10% down payment: The borrower is required to make a down payment of at least 10% (and in some cases more) on the loan.
• 40% certified development loan: A CDC offers financing of up to 40% of the loan amount. This amount is guaranteed by the SBA.
• 50% bank loan: A bank or a credit union offers the remaining financing, which needs to be at least 50% of the total loan amount.

How do SBA 504 loans work?

Because the SBA guarantees a portion of the loan, the loan has specific terms and requirements that you won’t find with a typical commercial loan.

Loan amounts

The maximum loan amount for the CDC portion of the loan that is guaranteed by the SBA is $5 million. However, this amount increases to $5.5 million for small manufacturers and some green energy projects and companies.

The third-party lender — a bank, credit union or other lender — is required to provide at least 50% of the funding. The SBA doesn’t restrict the project size, so a third-party lender can lend you more than the required 50%, meaning your loan can be $20 million or more.

Down payment

As a borrower, you’re required to make a down payment of at least 10% of the total loan. In some cases, you may be required to make a down payment of up to 20%.

If you’ve been in business for less than two years, or if the loan is to be used for a limited-market or special-purpose property (e.g., amusement parks, bowling alleys or gas stations), you’ll put down at least 15%. If you’ve been in business for less than two years and the loan will be used for a limited-market or special-purpose property, you’ll put down 20%.

Terms

The term length of the CDC loan ranges from 10 to 25 years, depending on your intended use for the loan. Machinery or equipment typically has a loan term of 10 years, while real estate usually has a loan term of 20 or 25 years.

You’ll negotiate the bank loan terms with your lender, but the term needs to be at least seven years for a machinery or equipment loan and at least 10 years for a real estate loan.

Rates

A benefit of participating in the SBA 504 loan program is that the SBA-backed portion of the financing usually comes with below-market interest rates. These interest rates are fixed over the life of the loan and usually correlate with the interest rate for five- and 10-year U.S. treasury bonds. As of October 28, 2022 rates are approximately 3% of the total amount financed.

Fees

There are a number of fees that banks, CDCs or the SBA may charge, so it’s a good idea to ask for a breakdown. They may be baked into the total loan. These fees may include:

• Processing (packaging) fee
• Closing fee
• Servicing fee
• Late fees
• Assumption fee
• Underwriter fee

Who is eligible for an SBA 504 loan?

Before you can qualify for an SBA loan, there are some CDC/504 loan program eligibility requirements that you’ll need to meet. Specifically, you must:

• Operate as a for-profit business (passive or speculative businesses are not allowed)
• Fall within the size standards set by the SBA
• Have a tangible net worth of $15 million or less
• Have an annual net income of $5 million or less for the two years prior to application
• Borrow money for an approved use (see more below)

Approved uses for SBA 504 loan funds

SBA loans can be used to purchase fixed assets, including:

• The purchase of an existing building, land or land improvements (grading, street improvements, utilities, landscaping and parking lots)
• The construction of new facilities or modernization, renovation or conversion of existing facilities
• The purchase of new machinery, with a useful life of at least 10 years
• The refinancing of debt that was used for building new facilities, renovating existing facilities or buying machinery

If you’re planning to lease part of the building that you purchased or built with the loan proceeds, the SBA has rules about how much of the building must be owner-occupied. A borrower who purchases an existing building needs to occupy at least 51% of the building. For new buildings, the borrower needs to occupy at least 60% of the building, with the goal of occupying at least 80% of the building in the next 10 years.

Note that you can’t use SBA 504 loan funds for working capital, inventory or consolidating or repaying debt.

How to get an SBA 504 loan

If you’re ready to apply, remember that there are two lenders you’ll need to work with: a CDC and a third-party lender, like a bank. You can start the process by contacting either a CDC lender or a third-party lender.

You can use Lender Match on the SBA website to help you find an SBA-approved CDC lender that can get you started on the process. Alternatively, many borrowers start the process by inquiring with a commercial lender about a loan. From there, the lender refers borrowers to the SBA 504 program and a CDC lender that can assist with the process.

When you apply for the loan, you’ll be required to submit a number of documents to the CDC as a part of your loan application, including:

• An analysis of the applicant’s pro-forma balance sheet
• An analysis of repayment ability
• Financial statements with trends and industry comparisons
• A discussion of the owner’s personal credit history and experience

The CDC will then submit this information to an SBA loan processing center. If the CDC you’re applying with is part of the Accredited Lender Program, the loan documents will go through an expedited approval process.

Expediting your application process

According to Claudia Cohen, senior vice president and director of marketing at Capital Access Group, a CDC, there are steps that borrowers can take to help speed up the loan process. Prepare now if you’re considering an SBA 504 loan.

“Go to your CPA, get your books together, have your tax returns ready to go, both personal and corporate, have your financial statements, P&L and balance sheet ready to go, so that when we ask for this, it’s easy to provide it,” Cohen said, noting that this preparation helps the preapproval process go more quickly.

The typical escrow period to expect is 60 days, though it can be longer.

SBA 504 vs. 7(a): What’s the difference?

Here’s a how the 504 loan compares with the 7(a) loan at-a-glance:

The SBA 7(a) loan program is a larger loan program that offers greater flexibility to borrowers. Like the 504 loan, the SBA partially guarantees loans, but the borrower only works with one commercial lender, meaning you won’t work with a CDC like you would with a 504 loan. The SBA 7(a) loan program also offers funding for many other uses beyond fixed assets, including working capital and debt refinancing.

While an SBA 504 loan is less flexible than a 7(a) loan, there are advantages to using a 504 loan if you’re purchasing fixed assets. The term length is typically much longer than a 7(a) loan, which usually has an average term length of only 10 years. The interest rate is also lower than a 7(a) loan, and it’s a fixed-rate loan, while 7(a) loans may have a variable interest rate.