At some point or another, your small business likely will need financing to reach its goals. The Small Business Administration (SBA) offers multiple initiatives to help business owners like you receive capital, including the 504 loan program. 

Whether you’re seeking an SBA 504 loan for startup funding or need capital to run and grow your business, this program can be a great option for you.

About SBA 504 Loans

For many company owners, small business loans can be difficult to obtain. Banks have strict criteria to meet and other lenders tend to offer higher rates and fees, which can make them cost-prohibitive. 

Fortunately, the SBA wants to make it easier for you to get the funds you need to advance your business.

As with most SBA loans, the 504 program is focused on building up America’s small business infrastructure. The SBA accomplishes this by helping owners finance their business in exchange for stimulating local economies and creating jobs. The agency has attributed more than 2 million jobs to their loan initiatives. 

It’s considered a win-win for everyone involved: owners get the funding they need, more jobs are available for workers and the economy grows. Note that the benefits of SBA 504 loans for veterans, minorities, women and business owners in general are numerous.

That said, there are specific requirements you need to meet, and the structure of these loans can be difficult to understand, but we’ll explain what you need to know to evaluate and apply for an SBA 504 loan.

How SBA 504 Loans Work

It’s important to understand how 504 loans differ from other SBA loan programs before applying. Instead of acting as a guarantor to a portion of the financing — as seen in the 7(a) initiative that includes Express loans — the SBA acts to entice conventional lenders to accept your loan by guaranteeing a chunk of the loan amount, referred to as a debenture, offered through their partners, Certified Development Companies (CDCs).

Certified Development Companies

A CDC is a nonprofit corporation that’s regulated and certified by the SBA. CDCs work with lenders to facilitate 504 loans under the structure the SBA provides. There are about 270 CDCs nationwide. Each CDC services a specific territory in which they work with businesses seeking funding in that area.

Find assistance applying for an SBA 504 loan in your area with SBA’s CDC search tool.

SBA 504 Loan Structure

The structure of 504 loans is complicated. The loan is serviced by two parties. If approved, you’ll essentially be getting two separate loans: one from a conventional lender, or bank, and one from the CDC backed by the SBA. Together, with a modest down payment, the two loans make up the total financing you need to get your project started.

The breakdown is as follows:

  • Conventional lender: 50%
  • CDC: 40%
  • Down payment: 10% (in some cases, a borrower may be required to put down up to 20%)

SBA loan structure pie chart showing breakdown of loan: 50% from conventional lender, 40% from CDC and 10% down payment.

There are some exceptions, however. CDCs are only allowed to contribute up to $5 million ($5.5 million for some small manufacturers and businesses qualifying for specific energy projects) in funding for SBA loans. 

SBA restrictions don’t bind lenders, however. They can provide 2-3 times that amount, which would throw off the previously noted percentages. 

Also, CDC loan percentages could go down in certain instances, with a higher down payment percentage required by borrowers. This would only apply in certain cases. 

Specifically, your down payment down could be raised to 15% if your business is a startup or the real estate you’re financing is considered special-use property (e.g., amusement park, car wash, theater, winery, etc.). If both factors apply, your down payment requirement would be at least 20%.

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Projects 504 Loans Are Used For

Unlike some 7(a) loans, the 504 program is more specific in terms of what you can use the funding for. In general, the money must be allocated towards expanding your business. Expansion means more jobs, which is the heart of what the 504 program is all about. 

Examples of qualifying uses include fixed assets, such as commercial real estate and equipment for your business, as well as necessary remodeling and upgrades that will help your business grow. SBA 504 loans can’t be used for working capital, inventory or for purchasing rental real estate.

(Note: If using the program to finance real estate, you must occupy 51% of the space for existing structures and 60% for new construction to qualify. This number will rise depending on the SBA 504 terms laid out in your loan agreement.)

In the past few years, the SBA has opened up 504 loans to debt refinancing, but there are restrictions on what type of debt qualifies under the 504 program. To qualify, the business must have been in operation for at least 2 years and the debt to be refinanced must be a commercial loan that meets these requirements:

  • Incurred for the benefit of the small business not less than 2 years before application for 504 refinancing
  • Proceeds were used to acquire 504-eligible fixed assets, such as real estate, land, equipment, etc.
  • Secured by 504-eligible fixed assets
  • On-time payments for the last 12 months

Existing debt to be rolled into a 504 loan is limited to 50% of the new costs. 

Eligibility and Requirements for SBA 504 Loans

There are certain requirements that are generally needed to acquire any SBA loan, as well as some specific to the 504 program. Remember that these requirements are for the loan provided by the CDC only. The lender that is working with them to fund your project may have additional criteria — including credit score and annual revenue minimums — you must hit.

General Business Prerequisites

First, your business must be conducted for-profit within the U.S. and fall under the SBA’s size standards guidelines to qualify. A business qualifies if it has a tangible net worth of $15 million or less. Additionally, the business’s average net income couldn’t have exceeded $5 million after federal income taxes for the previous 2 years.

As an owner, you must have shown that you require funding and have exhausted alternative financing options, including investing your own time and money into the business. Certain types of businesses are not able to apply for an SBA 504 loan, including companies that are engaged in lending practices or promote gambling or illegal activities.

Specific SBA 504 Loan Qualifications 

You must also meet specific SBA 504 loan qualifications. Start by having a sound plan in place that proves the funding is a smart investment for both you and the SBA. You must demonstrate that a loan will help you grow and create jobs.

If approved, your business must create or retain 1 job for every $65,000 that is guaranteed by the SBA debenture on the CDC loan (this number jumps to $100,000 for qualifying small manufacturers). Seventy-five percent of these jobs must be kept within your community, meaning you can’t outsource these jobs and must promote local economic growth.

Also, you may circumvent the job-creation requirements if the funding will help your business meet other community development and public policy goals, including but not limited to the following:

  • Improving, diversifying or stabilizing the local economy
  • Promoting the development of other local businesses
  • Expanding opportunities for women, minorities and veterans
  • Upgrading or remodeling facilities to meet health, safety and environmental regulations

You must provide the lender and the CDC with a strong proposal on how you’ll reach these goals to be considered for the SBA 504 loan program. 

Failure to show a plan that will result in a win-win for the SBA and your business will likely result in the rejection of your SBA 504 loan application.

Terms, Rates and Fees for SBA 504 Loans

The purpose of all SBA loan programs is to provide businesses like yours with access to funding under reasonable terms. To accomplish this, they extend financing with longer payment lengths and lower rates than you’ll find with alternative lenders, keeping money in your pocket and stimulating the economy.

SBA 504 Term Lengths

Depending on your use of funds, the repayment length will vary between the bank and CDC portion of your 504 loan.

Table showing CDC and bank loan terms for a 504 loan: CDC loans are for 10, 20 or 25 years; banks terms are 7 or 10 years.

By having longer term lengths, SBA 504 loans allow you to spread out and lower payments, making them a desirable option for larger and more expensive projects.

Interest Rates and Fees

As with the repayment lengths, interest rates and fees are different within the two individual parts of your loan. Banks can set variable or fixed rates for the borrower and will impose their standard fees, though the SBA sets caps that lenders can’t exceed. 

Specifically, third-party lenders can’t charge more than 6% above the prime rate (or the maximum interest rate allowed by state). As of February 2020, the prime rate is 4.75%. Because these lenders are only responsible for financing a percentage of your project, it may be easier to negotiate a lower interest rate with them than it would normally be. 

The CDC always provides fixed rates with a fully amortized structure to help keep your financial commitments consistent. Interest rates for 504 loan programs are tied to current 5- and 10-year U.S. Treasury rates. The interest rate for the CDC portion of your SBA 504 loan could be about 3%-5%, generally lower than what you’d find with an alternative lender.

There are a few fees that you will want to consider on the SBA-backed portion of your loan. The price of some of these fees may vary by borrower and others have a cap that can change. However, according to the SBA, fees are about 3% of the 504 portion of the loan and can be financed with the loan. The following fees are included in the CDC portion of your loan:

  • SBA 504 guarantee fee
  • Servicing agent fee
  • CDC fee

Prepayment fees apply during the first 10 years of the loan, declining a slight percentage each year. Also expect processing, appraisal, legal, underwriting and other fees usually standard in small business loans. Before you apply, check in with your local CDC to find out what the current rates are.

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SBA 504 vs. 7a Loans

In comparison with the SBA 504 loan, the 7(a) works a bit differently. When considering the SBA 504 vs. 7(a) loans, understand that SBA 7(a) loans are funded by lenders who partner with the federal agency (there’s no CDC involved). The SBA guarantees up to 85% of the loan amount, depending on the specific type of 7(a) loan, and loans can go up to $5 million. 

Repayment terms can range from 5-25 years, depending on use of funds. Additionally, funding use is less restrictive with a 7(a) loan. You can use a 7(a) loan for renovation and expansion projects, new construction, equipment, fixtures, inventory, working capital and debt refinancing.

Applying for an SBA 504 Loan

Once you’ve reviewed SBA 504 loan guidelines, checked your eligibility and determined that the 504 loan program is the right fit for your business’s needs, it’s time to put together what you need to apply.

Most importantly, put together a plan to prove to the SBA that they should invest in your business. This document should include exactly how you’ll use the funding, why it’s necessary to your business and how it will meet the job-creation or community development goals the 504 program wants to reach.

Once you have your plan in place, gather your financial documentation that will be used to evaluate your loan request: 

  • Personal and business tax returns
  • Personal financial statements (required from each individual owning 20% or more of the company)
  • Profit-and-loss statement
  • Balance sheet
  • Collateral (the equipment or real estate that is financed in the loan is usually enough, but more collateral is sometimes required)

You’ll also want to consider how to cover the minimum 10% down payment required to secure the loan. You could use personal savings, your 401(k), or even a private loan, barring your personal finances are separated and you use a source of income outside of the business to pay it.

When you have everything together, send all of the documentation to your bank and local CDC, who will share it with the SBA and help facilitate your SBA 504 loan application. 

If you’re approved, you’ll then negotiate any terms and come to an agreement on both parts of the loan. If you happen not to get approved, don’t worry. There are alternative business loans available. Be sure to explore all of the options available to get your business what it needs to expand and grow.

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