A Small Business Administration (SBA) 504 loan is a government-backed loan that provides businesses with funds to purchase real estate and other fixed assets. Using a 504 loan, eligible businesses can finance up to 90% of costs related to buying or improving real estate, equipment, and other items for up to 10 or 25 years at rates starting at just 2.5%.
While an SBA 504 loan can be great for some small businesses, these loans can only be used for certain expenses. They also involve fees – including guaranty fees – that not all business loans have.
What is an SBA 504 loan?
The 504 loan program was originally established by Section 504 of the Small Business Investment Act of 1958. These loans were designed specifically to help businesses finance investments in fixed assets like real estate. Loans are actually restricted, in that businesses can only use funds borrowed through the program for certain things.
Under the 504 program, businesses can borrow up to a maximum of $5 million ($5.5 million for some small manufacturers) for up to 10 or 25 years (10 years for equipment; 25 for real estate).
How do SBA 504 loans work?
Unlike other SBA loans, which are issued by banks, SBA 504 loans are loans that are issued by a Certified Development Company (CDC) and partially-guaranteed by the SBA.
The program works like this:
- A business owner decides that they need capital in order to invest in new or improved facilities, equipment, or other fixed assets.
- A business tries to get a loan elsewhere. SBA loans are considered loans of last resort – they aren't intended to be the first option for small businesses. Those who can secure funding through conventional bank loans and other sources are supposed to use those other avenues before resorting to an SBA loan.
- The business owner decides if they're eligible for an SBA loan.
- The business owner identifies a local certified development company (CDC) and completes a loan application.
- If approved, the business owner makes a down payment of 10-20% of the total cost of their project. The CDC provides up to 50% of the projected costs, and the SBA provides up to 40%.
- The business owner uses their own funds in combination with funds from the CDC and the SBA to invest in the fixed assets they identified.
SBA 504 loan eligibility
To get a 504 loan, a business owner must first demonstrate that they're eligible for the program. Eligibility criteria for the SBA 504 program are very strict; business owners must meet the SBA's requirements for 504 loans, which mandate that:
- The business has a tangible net worth of $15 million or less.
- The business has an average net income of $5 million or less (after federal income taxes) for the two years preceding the loan application.
- The business must be a for-profit, active operation, and it can't be engaged in speculation.
Additionally, in order to get an SBA 504 loan, businesses are required to create or retain at least one job for every $65,000 guaranteed by the SBA (one job for every $100,000 for small manufacturers).
Alternatively, businesses may be able to qualify if they meet community development or public policy goals. According to the SBA, these objectives include:
- Improving, diversifying or stabilizing a local economy
- Stimulating other business development
- Bringing new income into a community
- Revitalizing a business district of a community
- Expanding exports
- Expanding women-, minority-, or veteran-owned businesses
- Aiding rural development
- Increasing productivity and competitiveness (retooling, robotics, modernization, competition with imports)
In addition to these requirements, in order to be eligible, a borrower must be capable of contributing at least 10% of the cost of their project. They will also be required to secure their loan with assets the funds are being used to purchase or improve. Last, personal guarantees will be required from anyone who owns 20% or more of the business taking the loan.
What can an SBA 504 loan be used for?
Like other types of SBA financing, SBA 504 loans can only be used by for-profit businesses. However, unlike some other types of business loans, SBA 504 loans can only be used for certain things. These loans can't be used for speculation; they're only supposed to be used to invest in fixed assets.
Eligible uses of loan funds
The 504 loan program is only to be used to invest fixed assets, like real estate and equipment. The program covers both acquisitions and improvement; business owners can use the program to finance things like:
- Buying a new facility
- Expanding or improving current facilities
- Buying new equipment
In addition to these restrictions on the use of funds provided through the 504 loan program, business owners who get a loan must also create or retain one job for every $65,000 or $100,000 that the SBA guarantees. Therefore, business owners are wise to use funds in a way that will promote job growth or retention.
What businesses are SBA 504 loans good for?
Any type of business can qualify for an SBA 504 loan, so long as it's not "engaged in nonprofit, passive or speculative activities." In addition, businesses must meet the SBA's definition of a small business, which typically means fewer than 250 to 1,500 employees, depending on the industry.
The following types of businesses often face high fixed-asset costs and can benefit from an SBA 504 loan:
- Manufacturers
- Engineering and construction companies
- Logistics firms
- Industrial or warehousing operations
- Packing or bottling plants
- Tooling plants
Among the companies that have the easiest time qualifying for 504 loans are those with steady payrolls, as they can more readily meet the SBA's job creation or retention requirements.
Businesses in rural communities that need jobs can also benefit from the program, as can those that are owned by women, minorities or veterans. Companies that do business internationally and can use their loan funds to increase exports are also prime candidates.
If you aren't sure whether an SBA 504 loan will work for you or have questions about loan eligibility and requirements, contact a certified development company in your area for more information.
SBA 504 loan rates and fees
Like any other type of loan, SBA 504 loans charge interest. There are also fees that borrowers may not be familiar with if they haven't used SBA loans before. In addition to the fees charged by the SBA, many lenders charge their own fees, separate from the SBA's, including origination fees that increase the upfront costs of 504 loans.
SBA 504 loan rates
SBA 504 rates are fixed for the term of the loan but fluctuate over time based on the yields of five- and 10-year U.S. Treasury bonds. The interest rate may also vary by the loan term. Currently, the lowest available rates for SBA 504 loans are about 2.5%.
Loan fees
The fees charged for SBA 504 loans vary by CDC and SBA lender. However, there are some fees that the SBA charges that are relatively consistent:
- Upfront SBA Guarantee Fee: 0.50%
- Ongoing SBA Borrower Fee: 0.3205% (0.322% for refinancing loans)
While these are the base fees charged by the SBA, fees for individual loans may be higher, depending on which lender or CDC you work with. For example, some of the SBA lenders that we researched quoted upfront loan origination fees (including the upfront SBA guarantee fee) of approximately 1.5% – a full percentage point higher than the base fee being charged by the SBA at closing.
504 repayment terms
Using an SBA 504 loan, small businesses can secure financing that lasts for up to 10 to 25 years. Loan terms can last as long as 25 years when secured by real estate; 10 years for equipment. Interest rates are fixed for the term of a loan.
SBA 504 loans can also be paid back early. However, there are prepayment penalties for paying a loan back early that start at an interest rate of 3% in the first year of the loan and decline over the next 10 years. Prepayment penalties fall to 0% in year 11 of a loan. Prepayment penalties only apply to loans with terms of 15 years or longer.
SBA 504 loan application process
There are multiple parties involved in applying for an SBA 504 loan, including the business owner, a CDC, and an SBA-approved lender. Here are the steps you'll need to follow to secure the financing you need for your small business:
1. Identify an investment.
Before you apply for a loan, have an idea of what you're trying to invest in. That way, you can decide whether a 504 loan is right for you and how much you need to borrow.
2. Prepare your records.
In order to apply for an SBA loan, your lenders are going to need to review quite a few records, so it's a good idea to gather certain documentation before you apply.
Some records the lender will need include:
- Two to three years of business tax returns
- The business's balance sheet
- Breakdown of company ownership
- Financial records for anyone who owns 20% or more of the company
In addition to these records, you may also need payroll records to prove eligibility for an SBA loan and to demonstrate your ability to meet job creation and retention requirements.
3. Find a CDC.
Once you have your records together, you'll need to find a CDC in your area to provide 40% of your overall financing costs. The CDC can also confirm your eligibility for the 504 program and that you will use the funds for an approved purpose.
If you have an existing relationship with a bank that is an SBA-approved lender, your bank may be able to recommend one or more CDCs in your area.
4. Apply with the CDC.
After you choose a CDC, you'll need to file a loan application. The CDC will put your loan through a full underwriting process, including a review of your books and records.
5. Find a conventional SBA participating lender.
Once you have approval from a CDC for 40% of your projected costs, you'll need to find a conventional lender – usually a commercial bank – to underwrite the portion of your financing to be guaranteed by the SBA. This lender will be different from your CDC and will provide up to 50% of your total projected costs. They will also charge their own fees.
If you aren't sure which lender to use to underwrite the SBA portion of your financing, you may want to consider using a bank that's already an active SBA lender. These lenders will be the most familiar with the process.
6. Apply for the SBA portion.
The last step before approval is to work with your conventional lender to file an application for the SBA portion of your financing. This step will likely involve some duplication of effort from the lending process with the CDC, but any redundancy will be necessary. This step may also involve a fee, depending on the lender, but borrowers should be wary of any lender that charges application fees.
7. Close on the loan.
Once you have the approval of both the CDC and a conventional lender, you can close on your loan. This is also when you will be charged an origination fee for securing your loan. Typically, a lender will charge a loan origination fee of 1-2% of the amount it's providing that includes the SBA's upfront guarantee fee of 0.50%.
In total, the time required to get approved for an SBA 504 loan is typically up to six months. After approval it can take 30-45 days to secure funding. If you're hoping to secure funding faster, you may be able to speed up the process by getting prequalified with a CDC and/or a conventional lender.
Where to get an SBA 504 loan
In order to get an SBA 504 loan, you'll need to work with a CDC. But, you'll also need to work with a bank to help you prepare to apply, to help with the SBA portion of your loan, and to help you select a CDC to work with. If you're going to work with a bank, be sure that you work with an active SBA lender.
The most active SBA lenders
| Lender | Number of SBA 7(a) Loans Approved in 2019 |
| Huntington National Bank | 1,538 |
| U.S. Bank | 1,374 |
| Wells Fargo | 1,264 |
| TD Bank | 1,028 |
| JP Morgan Chase | 844 |
| Manufacturers and Traders Trust | 637 |
| First Home Bank | 523 |
| Live Oak Bank | 456 |
| Newtek Small Business Finance | 415 |
| Stearns Bank | 297 |
Pros and cons of SBA 504 loans
Pros
- Business owners can finance up to 90% of the projected costs.
- You can get financing for up to 10 to 25 years.
- Loans are fully amortized, so you don't have to worry about balloon payments.
- All loans offer fixed interest rates.
- Interest rates are lower than most conventional business loans.
Cons
- SBA guaranty fees add to the cost of the loan.
- Funds must be used to buy or improve fixed assets.
- Only certain businesses qualify.
- Businesses must create or retain jobs as a condition of their loan.