What Is an SBA 504 Loan, and How Does It Work?

SBA 504 loans are fixed-rated, long-term loans for small businesses offered through the U.S. Small Business Administration (SBA). The SBA 504 program supports small business growth and job generation. These loans are funded by Certified Development Companies (CDCs) and third-party lenders and guaranteed by the SBA. They typically require the borrower to have at least 10% equity.

SBA 504 loans have a number of eligibility requirements and rules on how borrowers can use the funds. Like all financing, SBA 504 loans come with fees, interest, and specific repayment terms.

How SBA 504 Loans Work

SBA 504 loans are a financing solution for small business owners who want to purchase real estate or equipment. It can be a good option for small business owners who do not qualify for conventional financing.

The U.S. Small Business Administration (SBA) backs the loans, but it does not provide the funds. CDCs, which are economic development nonprofits, work with banks and credit unions approved by the SBA to provide the funding.

A CDC will provide 40% of the funding, while an SBA-approved bank or credit union will provide 50%. Borrowers are responsible for making a 10% contribution.

Main Features of an SBA 504 Loan

SBA 504 loans have specific features that dictate how much you can borrow, how much the loan will cost, and how you can use the funds.

Maximum Amount

Certain eligible energy-efficient or manufacturing projects can qualify for up to $5.5 million in funding. In most cases, the maximum SBA 504 loan amount is $5 million.

Minimum Credit Score

The SBA does not list a minimum credit score requirement for borrowers. SBA lenders may have their own credit score requirements.

Down Payment

Borrowers typically make a 10% down payment on SBA 504 loans.

Fees

Fees are typically 3% of the 504 part of the loan. Borrowers may have to pay a processing fee, guaranty fee, funding corporation fee, and bond broker fee. Fees can be rolled into the loan amount and therefore financed.

Interest

SBA 504 loan rates are fixed-rate loans. The loan interest rates are set to an increment above the market rate for five- and 10-year U.S. Treasury issues.

Terms

SBA 504 loans are offered for terms of 10, 20, or 25 years.

Uses

Small business owners can use SBA 504 loans for different purposes. You can:

• Buy existing buildings or land
• Buy long-term machinery and equipment
• Construct new facilities
• Make improvements to land, streets, utilities, parking lots, landscaping, and existing facilities

Time for Funding

It can potentially take you months to go through the application period and processing to receive the funds. SBA loans typically take longer to process than private loans because they have requirements from both lenders and the SBA.

Eligibility Requirements to Get an SBA 504 Loan

To qualify for an SBA 504 loan, you must meet several eligibility criteria.

SBA Requirements

• You must operate a for-profit company.
• You have to do business in the United States.
• You need a feasible business plan and relevant management experience.
• You cannot have other available sources of funding.
• Your net worth must be less than $15 million.
• Your average net income must be less than $5 million after taxes for the two years prior.
• You cannot be engaged in activities like speculation in rental real estate, loan packaging, gambling, multi-sales distribution, or illegal activities.
• You must be able to demonstrate the ability to repay the loan with projected operating cash flow from your business.
• You must demonstrate good character, which is defined by a history of paying debts and obeying the law.

Lender Requirements

Lenders require borrowers to meet all SBA eligibility criteria. SBA lenders may also have their own criteria, such as minimum credit scores or income requirements, which they use to evaluate potential borrowers.

Project Requirements

Borrowers can use SBA 504 loans to buy or build buildings, land, new facilities, and machinery or equipment. They can also use the loan to improve existing facilities. They cannot use the funds for working capital, debt consolidation, or rental real estate investment.

How SBA 504 Loans Compare to Other SBA Loans

The SBA also offers 7(a) loans and microloans. Let’s look in more detail at how both of these loan types compare to 504 loans.

SBA 504 Loan vs. SBA 7(a) Loan

The 7(a) loan program, the SBA’s most common loan program, offers several different types of loans. Small businesses can receive a maximum of $5 million through this program. SBA 7(a) loans can be used for working capital, refinancing business debt, machinery, equipment, furniture, fixtures, and supplies. Borrowers must provide collateral for loans of $25,000 or more.

SBA 504 Loan vs. SBA Microloan

SBA microloans offers small businesses $50,000 or less in funding. Small businesses can use these loans for working capital, equipment, fixtures, furniture supplies, and inventory.

How to Apply for an SBA 504 Loan

You will need to find a CDC to apply for an SBA 504 loan. The SBA offers a resource that allows you to search for local CDCs. The CDC and the borrower will complete an application, which the SBA will use to determine the applicant’s eligibility for the loan. You will need to provide personal information and information about your business.

Repaying an SBA 504 Loan

You will repay your SBA loan in monthly installments determined by your loan total, interest rate, and terms. Payments can be made by Automated Clearing House (ACH), wire, or check.

You can ask your CDC about any payment questions you have.

The Bottom Line

SBA 504 loans can be an affordable financing option for small business owners who qualify. Borrowers can compare SBA 504 loan features, fees, interest, and terms with other financing options to decide what works best for their small business.