The SBA 7(a) loan is a fantastic financial option for promising small businesses looking to expand, but it’s not by any means a charitable donation. Lenders need something in return for their capital, which is why the SBA does include prepayment penalties in 7(a) loans.
However, the rules are a little more complicated than you might think. Depending on the nature of your loan agreement, you may be granted an opportunity to pay loans off early without penalty.
Why Do Prepayment Penalties Exist?
It seems incredibly unfair, doesn’t it? You’ve been careful with your money, and you’ve worked hard on your business. Now your hard work is paying off ahead of schedule, you want to do the responsible thing and pay off your debts, but you can’t.
Why is this? Surely the lender will be happy to receive their investment back ahead of time, right? Well, actually no, not at all.
Lenders don’t just invest in businesses out of the goodness of their hearts. For lenders, borrowers are simply a business opportunity, and the only reason they pay out is that they stand to make significant financial gains by doing so.
This return on their investment is, of course, known as interest. Interest is accrued over time with each payment. When you repay more than the agreed-upon amount, you’re essentially shortening the term, which means the lender isn’t going to earn as quite as much interest as was promised when the terms were hammered out.
So, to protect the lender’s investment and make sure they received what’s owed, loans will include disincentives in the form of prepayment penalties to deter borrowers from undercutting the lender.
Will I Be Charged Prepayment Fees for Paying off My 7(a) Loan Early?
Prepayment penalties can be incredibly annoying. They can stop you from clearing your debts or refinancing for a better deal with lower interest rates, but there’s a good chance that you may be exempt from this financial prison cell.
There are a few factors to cover here, but the most important thing to remember is that if the repayment term of your 7(a) loan is less than 15 years, you’ve got nothing to worry about. That’s right, folks. If you’ve secured a short-term SBA 7(a) loan (congratulations), you won’t get hit with any fees if you choose to pay it off early — hurray!
Having said that, it’s always best to check with the SBA first before you act in any way that deviates from the written agreement. The last thing you want to do is accidentally incur additional fees.
If the SBA gives you the green light, then you’re good to go. Pay that loan off as fast as you can, so you can start seeing some real success!
If you can’t quite pay it off with your own capital, but you’ve found another lender who’ll offer you lower interest rates, refinancing is a shrewd move.
But does this mean if you have a repayment term of 15 years or above that you will get stuck with prepayment penalties? Well, not necessarily.
Yes, 15 years is the threshold at which the prepayment penalties become a possibility, but there are finer points in the rules that make them very easy to avoid.
Firstly, you’ll only be struck by a prepayment penalty if you overpay 25% or more of your overall outstanding debt. So, let’s say that your remaining debt comes to $1,000,000. If you paid $250,000 or above in one month, you’ll be subject to a penalty. Anything less than that, and, technically, you’re all good.
Of course, in certain situations, an overpayment may not be voluntary, as it might have been ordered by the SBA or the lender, in which case, you will not have to pay any sort of fee, as you have not willingly deviated from the rules of the loan.
The next thing you should know is that after three years of repayments, you will no longer have to worry about prepayment penalties, and considering your repayment term is 15+ years, that’s really not so long to wait.
If you’re lucky enough to be able to make extra repayments so soon after securing the 7(a) loan, just be patient. Those three years will fly by, and then you won’t end up out of pocket due to prepayment penalties.
What Are the Prepayment Penalties of SBA 7(a) Loans?
I know what you’re thinking...what exactly do these prepayment penalties entail? Well, you’ll be happy to hear that the SBA is a little more lenient than a lot of other lending organizations.
Rather than charging an amount based on the overall outstanding loan (which can be steep), they calculate the fee based on the amount you prepaid and in which of the three years the overpayment took place.
Say that you overpaid in the first year of the repayment term. You’d be charged 5% of the amount you overpaid. So, bringing back our example from earlier, if you paid $250,000 on a $1,000,000 outstanding sum, you’ll be charged 5% of 25K, which is $12,500.
The percentage of the fee decreases incrementally as the years progress, for instance, if you overpay 25% or more of the outstanding loan in the second year of the repayment term, you’ll only be charged 3% of the amount you overpaid.
When you reach the third year in your repayment term, that figure drops to a very reasonable 2%. It’s not bad, but ideally, you’ll be charged 0%, as you’re already forking out plenty of interest, even over a reduced term.
One other minor consequence of incurring prepayment fees is that your credit score may go down a notch or two. It won’t be completely decimated, so don't worry too much about it, but it’s certainly something to consider.
That’s all there is to know about the prepayment penalties of the 7(a) loan. The key information here is that…
- You will not incur prepayment penalties on loans with terms less than 15 years.
- You will not incur prepayment penalties on loans with terms upward of 15 years, after 3 years of the term have elapsed.