SBA 504 loans are a popular financing option for small businesses looking to purchase real estate, acquire major equipment, or invest in long-term growth. These loans, backed by the Small Business Administration, provide affordable, fixed-rate funding and are designed to support economic development and job creation.
To qualify, businesses must meet specific size, purpose, and operational criteria, and the application process involves collaboration with Certified Development Companies (CDCs).
Keep reading to learn more on SBA 504 loans, including the qualifications, benefits, and steps to apply for an SBA 504 loan.
Key Points
• SBA 504 loans are designed for small businesses to finance the purchase or improvement of fixed assets, such as real estate, machinery, or facilities, promoting long-term economic development.
• The loan is a partnership between a Certified Development Company (CDC), a bank or private lender, and the borrower. Typically, the CDC provides 40%, the lender 50%, and the borrower contributes 10% of the total project cost.
• Businesses must meet SBA size standards, demonstrate the ability to repay the loan, and use the funds for eligible projects, such as property acquisition or modernization.
• Borrowers can access up to $5.5 million for eligible projects, with repayment terms of 10, 20, or 25 years, and interest rates are fixed.
• Alternatives to SBA 504 loans include SBA 7(a) loans, online business loans, SBA Express loans, and equipment financing.
What Is an SBA 504 Loan?
An SBA 504 loan is designed to provide businesses with financing for major fixed assets. The goal is to help fuel both business growth and job growth using long-term financing up to $5.5 million. This program differs from the popular SBA 7(a) loan option, which lets borrowers use funds for working capital as well.
Although SBA 504 loans are structured through the U.S. Small Business Administration (SBA), potential borrowers must apply for funding through Certified Development Companies (CDCs).
These are approved lending partners that focus on local economic development. Approved borrowers receive 90% of their financing needs and must provide the remaining 10%. There are three maturity term options for SBA loans: 10 years, 20 years, or 25 years.
Recommended: Guide to SBA Loans
504 Loan Interest Rates
The borrower’s interest rate starts with a base rate, using either the current five- or 10-year U.S. Treasury notes market rate. Then an increment above that amount is used to calculate the interest rate for the loan.
Rates are fixed for the life of the loan. They’re typically low compared to other types of business financing.
What Can an SBA 504 Loan Be Used For?
The SBA outlines specific categories that 504 loan funds can be used for, as well as items that can’t be paid for using these funds.
Eligible assets you can purchase with these funds must be aimed to create job growth. This could include purchasing or constructing buildings, land, new facilities, machinery, or equipment.
The funds may also be used to improve or modernize land, streets, parking lots, landscaping, and utilities.
Prohibited expenses include working capital, inventory, debt consolidation, and rental real estate. In order to finance some of these categories, you might instead consider financing from the SBA or conventional small business loans.
SBA 504 Eligibility Requirements
SBA 504 loans are available to for-profit companies that have a tangible net worth of under $15 million. Additionally, the average net income must have been under $5 million (post-federal taxes) for the previous two tax years.
Applicants must also not have other resources available to them. Lenders review both the business’s assets and the owner’s personal assets, which may reduce the approved loan amount if they’re too high. The company’s cash flow and projected cash flow are also evaluated to ensure that it can afford to repay the loan. A personal guarantee is also required.
What Is a CDC Lender?
A Certified Development Company (CDC) is a non-profit organization focused on economic development in its local community. CDCs must be certified by the SBA and are regulated by the SBA as well.
CDCs review and approve applicants for the 504 loan program. Once a loan is approved, the CDC funds 40% of the loan amount through SBA funds, then sells 50% of the loan amount to a bank or other financial institution. The business must provide the remaining 10% of the funds.
CDCs are the only organizations certified to offer 504 loans. In order to apply for this type of financing, companies must find a local CDC through the SBA.
Pros and Cons of an SBA 504 Loan
| 504 Loan Cons | 504 Loan Pros |
|---|---|
| Restricted use of funds | Competitive interest rates |
| Job growth requirements | Large loan maximum |
Pros of 504 Loans
504 loans come with several distinct benefits:
• Low, fixed interest rates
• Large maximum loan amounts compared with other funding that’s typically available
• Low 10% down payment
In short, this can be an extremely affordable form of financing for small businesses ready to make major purchases or improvements.
Cons of 504 Loans
Of course, there are downsides to consider as well:
• Restricted use of funds
• The project you’re financing must lead to business and job growth in the community
• A personal guarantee is also required in addition to a 10% down payment. This is your binding promise that if the business can’t pay back the loan, you will personally be responsible.
Depending on your project, it may be worth comparing the SBA 504 vs. 7(a) loan programs to find the best small business loan option for you and your funding needs.
Recommended: How to Get a Small Business Grant
How to Apply for an SBA 504 Loan
Applicants submit their applications directly through a local CDC.
In addition to providing company and personal financials, you’ll also need to submit a “Statement of Personal History” to confirm the good character of all company principals. It looks at their past history of repaying debt as well as any legal history.
You must also show a business plan that outlines the projected costs you expect to incur. The CDC you work with will give you a specific list of required documentation.
Be aware that the loan approval process can be long. Many CDC lenders estimate it takes an average of one to three months before approved applicants will receive funding.
Recommended: Guide to Typical Small Business Loan Requirements
Alternatives to an SBA 504 Loan
There are many other options to consider instead of an SBA 504 loan depending on what exactly your needs are.
• SBA 7(a) Loan: Funds can be used more broadly with an SBA 7(a) loan, including for working capital and inventory.
• Online Business Loan: You can apply for an online business loan. Rates are typically higher, but the application process is usually faster.
• SBA Express Loan: For smaller loan amounts that can offer a fast turnaround time, you could also consider an SBA Express loan. These provide up to $500,000.
• Equipment Financing: Private lenders offer equipment financing to purchase assets. These loans are typically secured by the equipment itself. However, some lenders may also require a personal guarantee.
Recommended: Small Business Bankruptcy
The Takeaway
There are many different types of small business loans. The best financing option for your small business depends on your company’s finances, funding needs, and business structure. Whether you choose an SBA 504 loan or another type of financing, be sure to compare multiple options.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
Am I eligible for an SBA 504 loan?
There are several requirements you must meet in order to be eligible to apply for an SBA 504 loan. Your business’s tangible net worth should be less than $15 million and average net income must be under $5 million.
How can I use the SBA 504 loan?
SBA 504 loan proceeds must be used to purchase or improve assets that lead to business and job growth. This includes things like buildings, land, equipment, streets, utilities, parking lots, or landscaping.
What is a CDC lender?
A Certified Development Company (CDC) is an SBA-certified non-profit organization that administers 504 loans. CDCs focus on improving economic development in communities. You can find CDCs in your area by searching the SBA database of approved organizations.
What are the pros and cons of an SBA 504 loan?
SBA 504 loans come with low, fixed interest rates. Plus, at $5.5 million, the maximum loan amount is quite high. On the downside, funds can only be used for approved purchases and a 10% down payment is required, as is a personal guarantee for the funds.
Photo credit: iStock/svetikd
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