How Does An SBA 504 Loan Work?

An SBA (Small Business Administration) 504 loan may be a good option if you’re looking to buy a property, real estate, or certain equipment for a small business. SBA 504 loans do not tend to be as competitive as other popular general-use loan programs such as the 7(a) loan.

Therefore, you shouldn’t have to worry about fighting off as many applicants to secure your loan. The application process for 504 loans can be more complicated, however, so you should be prepared to spend more time on it. 

Qualifying for a real estate loan from your bank should be a cause for celebration. This means you have survived a rigorous process from the bank and come out on the other side shining.

Sometimes, it is best to look into real estate loans that are there to help lower-performing businesses. This is where the SBA 504 loan program steps in.

Today, we are going to guide you through how an SBA 504 loan works and what you should expect during the whole process. Let’s begin by taking a look at what an SBA 504 loan is.

How Does An SBA 504 Loan Work

What is an SBA 504 loan?

SBA 504 loans are also known as SBA 504/CDC loans. It is a government-backed loan designed to help businesses expand and create more job opportunities within businesses.

An SBA 504 loan can be used to finance new real estate projects, renovate already owned properties, or purchase new equipment and items for a business. While it can not help you with all of your working capital requirements, an SBA 504 loan does allow you to refinance.

This SBA loan program differs slightly from other SBA loans. This is because the funding comes from two different lenders. These are:

  • A certified development company (CDC)
  • A third-party institution such as a bank or online lender

Essentially, SBA 504 loan programs were set up to encourage banks to lend to those they wouldn’t usually lend to. This is done by reducing the loan-to-value (LTV) of a bank’s loan.

For instance, a typical scenario would see the bank lending 50% of the collateral value and a CDC would then make a loan (a debenture) for up to 40%. The remaining costs are then covered by the borrower.

This translates to the typical SBA 504 loan having a 90% LTV. The borrower is usually likely to cover a little more than 10% of the costs. This includes other costs and variances between the appraised value and purchase price.

CDCs can place their loans in the second collateral position. This means it is paid out by a foreclosed collateral sale but only after the first position lender is made whole. This is because the loan is guaranteed by the SBA.

75% to 80% LTV on real estate loans is quite normal for most banks. Therefore, a 50% LTV tends to be enough to push the credit for approval, even with any underwriting problems. 

As we mentioned, there are a variety of uses for 504 loans. However, because they are usually structured based on any collateral value, most are nearly always used to improve or purchase real estate.

What is a Certified Development Company (CDC)?

A CDC is essentially a non-profit corporation. It offers SBA-backed financing to small businesses that require funds to help them grow. Each CDC is certified and regulated by the SBA but these companies are not essentially a part of the government. 

CDCs have a goal to promote economic growth and development in different communities. Across the US, there are currently over 260 CDCs and it is easy to find one in your local area. Simply search the SBA website to find one that serves your local community.

You may be able to get help in securing an SBA 7(a) loan from your local CDC too. These provide financing for business acquisitions, working capital, and inventory. 

How does an SBA 504 loan work?

As already stated, SBA 504 loans provide businesses with financial help from two different sources: a CDC and a third-party lender. The government only backs the CDC part of your loan.

Therefore, there are certain rules if the funding comes from a CDC source compared to a third-party lender source.

The amount a lender puts forward towards a loan usually depends on how long your business has been running and what you’re using the funds for. In some instances, you may have to pay a more substantial down amount.

This may be the case if your business is less than two years old or if you’re looking to fund something that involves property with a unique design. This is known as a limited-market property.

Your down payment amount can also be determined by the use of a property. If you intend to fund a project involving a property that is only used for one purpose, otherwise known as a special-purpose property, your down payment may be higher.

One example is if you want to finance the build of a museum. This is considered a special-purpose property because it is specially designed for historical purposes.

This is how the portion of the loan is funded:

CDC

An established business that uses funds for a standard property - Up to 40%

A new business or using funds to finance a limited market or a special-purpose property - Up to 35%

A new business and using funds to finance a limited market or a special-purpose property - Up to 30%

Third-Party Lender

An established business that uses funds for a standard property - Starts at 50%

A new business or using funds to finance a limited market or a special-purpose property - Starts at 50%

A new business and using funds to finance a limited market or a special-purpose property - Starts at 50%

Borrower

An established business that uses funds for a standard property - Starts at 10%

A new business or using funds to finance a limited market or a special-purpose property - Starts at 15%

A new business and using funds to finance a limited market or a special-purpose property - Starts at 20%

How much can I borrow using an SBA 504 loan?

Technically, there is no limit to how much you can borrow. That being said, the SBA does set a maximum amount that CDCs can finance depending on the project.

Most businesses and projects can qualify for as little as $25,000 up to the Everest heights of $5 million. Projects that are involved in renewable energy or reduce their business’ energy consumption by 10% or more can sometimes get up to $5.5 million from CDC funding.

As there is no limit to your project’s costs, it tends to be down to your third-party lender to set a maximum amount for your 504 loan.

How much do SBA 504 loans cost?

SBA 504 loans have three types of costs: interest, fees, and a down payment. As mentioned above, business owners need to make a down payment of between 10% and 20% but this depends on the type of project and the time spent in business.

SBA 504 loans come with two interest rates:

  • Interest on the CDC segment of your loan
  • Interest on the third-party segment of your loan

The maximum rate for the CDC portion is based on the cost of the US Treasury bonds and this is undertaken by the SBA. Third-party lender rates are based on the prime rate of the Wall Street Journal. Both rates are fixed so your rate will not change throughout the entire loan’s lifespan. 

There are a range of different fees that may have to be paid on your SBA 504 loan. These include:

  • A guarantee fee - A guarantee fee of 0.5% of the CDC part of your loan is charged by the SBA.
  • A processing or packaging fee - Your local CDC may charge up to 1.5% of the CDC portion of your loan if they help put together your application. 
  • A closing fee - The CDC may charge this fee to cover any costs of closing your loan such as legal service charges or filing forms.
  • An Underwriter’s fee - Sometimes an upfront fee between 0.375% and 0.4% of your total loan is needed to be paid. This is to cover the costs of evaluating your application.
  • A servicing fee - Your loan servicer can charge an annual fee of 0.368% of your outstanding loan’s balance.

Other fees can be included such as a CSA fee, a participation fee, or a late fee. Speak to your CDC for more information when applying for an SBA 504 loan.