One of the biggest challenges in taking out a small business loan is figuring out which loans to apply for. The Small Business Administration (SBA) offers a variety of financing opportunities for small businesses that might not be approved for other types of loans.
When you compare SBA loans to conventional business loans, you’ll see that the former typically have more competitive rates and terms because the federal government guarantees a portion of the loan funds.
However, there are significant differences even within the SBA loan category. Here, we’ll look at two popular SBA loan programs: the 504 and 7(a) loans. Both offer high maximum loan amounts, but they vary regarding how you apply and how you can use the loan funds.
Key Points
• SBA 504 loans emphasize job creation, while 7(a) loans support general business growth.
• 504 loans fund major assets like buildings and equipment; 7(a) covers working capital and inventory.
• 504 loans are obtained through CDCs, whereas 7(a) loans are through private lenders.
• Both 504 and 7(a) loans typically require a 10% down payment.
• 504 loans offer terms up to 25 years, while 7(a) loans for non-real estate are up to 10 years.
SBA 504 vs. 7a Loans
| Feature | 504 Loans | 7(a) Loans |
|---|---|---|
| Maximum loan amount | $5 million | $5 million |
| Use of funds | Purchasing, improving, or modernizing buildings, land, facilities, etc. | Working capital, inventory, debt consolidation or refinancing, etc. |
What Is an SBA 504 Loan?
An SBA 504 loan provides financing for small businesses to fuel job growth in their local communities. Loans are available up to $5 million. The application process is unique because it goes through a certified development corporation (CDC).
A CDC is an SBA-approved organization that provides 40% of the loan from SBA funds and then sells 50% of the loan to a third-party financial institution. The borrower provides the remaining 10% for the project.
Key Features and Terms
504 loan interest rates are low compared to other types of financing. Repayment terms can last 10 years, 20 years, or 25 years. Eligible uses for the funds include:
• Purchasing or constructing buildings, new facilities, or equipment
• Improving or modernizing existing facilities, land, streets, or parking lots
Borrowers may not use 504 loans for inventory, working capital, or debt consolidation.
Recommended: SBA Loan Requirements
What Is a 7(a) Loan?
SBA 7(a) loans are the most common type of SBA loans. The maximum loan amount is $5 million, and the funds may be used for a broad range of purposes, including:
• Real estate
• Working capital
• Debt refinancing
• Purchase of supplies, furniture, and fixtures
Program Overview and Terms
Real estate loan repayment can extend as long as 25 years, while all other 7(a) loans last up to 10 years.
The SBA guarantees the majority of the loan, but you apply for it directly with a lender. The loan approval process typically speeds up if you choose an SBA Preferred Lender, because these lenders have a positive history processing SBA loans.
In addition to the standard 7(a) loan, there are other types available as well:
• 7(a) Small Loan
• Export Express
• Export Working Capital
• International Trade
• CAPLines
Main Differences Between SBA 504 Loans and 7(a) Loans
504 loans and 7(a) loans are two very distinct programs. It’s wise to understand the differences before you start the application process.
Use of Funds
Regarding how funds may be spent, 504 loans focus on job creation, while 7(a) loans are tailored for expanding business operations. With a 504 loan, you can use the funds for significant expenditures, such as purchasing new buildings, land, or facilities. Alternatively, you can improve existing property. And 504 funds may also be used to buy heavy equipment and machinery.
A 7(a) loan may be used more broadly. Businesses may still purchase real estate and equipment with these funds. However, the loan may also be used for working capital, inventory, and more.
Application Process
The application process for 7(a) differs significantly from that for 504 loans. A private lender originates a 7(a) loan. You may opt to work with an SBA-preferred lender to expedite the process.
A 504 loan, on the other hand, requires you to apply through an SBA-certified CDC. These community organizations specialize in economic development.
Recommended: Business line of credit
Fees and Down Payments for SBA 504 Loans and 7(a) Loans
The SBA requires a guarantee fee on all loans, which is charged on the portion of the loan guaranteed by the federal government. You may also be charged lender fees and a down payment.
SBA 504 Loans
• Down payment: The borrower must supply 10% of the loan amount as equity. An additional 5% is required for startups and/or loans for special-use property (such as a church, school, hospital, museum, etc.). Forty percent of the loan goes through the CDC using SBA funds, and 50% comes from a lender.
• SBA Guarantee Fee: Currently set at 0.5% for the lender portion of the loan, plus up to 1.5% for the CDC portion. Ongoing fees may also apply.
7(a) Loans
• Down payment: The borrower must make a 10% down payment.
• SBA Guarantee Fee: Depending on your loan’s size, it ranges from 0.52% to 3.75% on the lender portion.
SBA 504 vs. SBA 7(a) Loan: What’s Right for Your Business?
Choosing between an SBA 504 loan and a 7(a) loan may largely depend on how you plan to use the funds.
When You Might Consider an SBA 504 Loan
A 504 loan should be used to expand or improve your business in a way that aids job growth. Because you apply through a CDC specializing in economic development, prepare to craft a business plan demonstrating this impact. Buildings, land, and facilities can be purchased or modernized with 504 funds. Long-term machinery and equipment are also considered eligible expenses. A 504 loan might be a good choice if these guidelines align with your intentions.
However, remember you’re not allowed to use the funds for debt consolidation, inventory, or working capital. While those might help grow your business, they likely won’t substantially benefit the local workforce.
When You Might Consider an SBA 7(a) Loan
There are far fewer restrictions on using 7(a) loan funds. For instance, eligible expenses include short-term and long-term working capital, making 7(a) loans preferable if you want to expand a business. Still, your plans won’t meet the 504 job creation requirements. A 7(a) loan can also be used to acquire a new business or purchase real estate for your company.
The Takeaway
Take the time to evaluate all of your business’s financing options. As you examine SBA loan requirements and consider your needs, you may decide that neither a 7(a) nor a 504 is right for you.
To get an idea of all your small business loan options or to apply for a small business loan online, check out Lantern by SoFi. Use its fast online search for a personalized small business option in minutes.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
What’s the difference between the 504 and 7(a) SBA loans?
There are several differences. First, the application process is different. With a 504 loan, you apply through a certified development corporation (CDC). SBA 7(a) loans go through regular business lenders.
There are also differences in how you may use the funds. Acceptable uses for 504 loans are more restrictive, and you must demonstrate job creation. They’re usually used to purchase or improve major assets like property or machinery. However, 7(a) loans have a broader range of uses and may also be used for working capital, inventory, and debt consolidation.
Is an SBA Express loan a 7(a) loan?
Yes, SBA Express loans are 7(a) loans. This program has a lower maximum loan amount ($350,000) but offers a fast approval time of just 36 hours.
Which SBA loan is better for purchasing real estate or equipment?
If you’re looking to purchase commercial real estate or heavy machinery/equipment, the SBA 504 loan is typically seen as the best choice.
Can a business apply for both SBA 504 and 7(a) loans?
If you have strong credit and a stellar business, the SBA and your lender might be fine with you combining 7(a) and 504 loans.
Photo credit: iStock/Prostock-Studio
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