The 3 Primary Types of SBA Loans and How They Work

For small business owners seeking a long-term, low-cost financing solution, obtaining funding through the U.S. Small Business Administration remains one of the best available affordable borrowing options. That’s because, even though the SBA doesn’t directly loan funds to businesses, this government agency makes traditional bank loans more accessible to small business owners by guaranteeing up to 75% of the funds.

But did you know that all SBA loans are not created equal? Different loan programs offer different funding possibilities based on your business history, the amount of capital you need, and how you plan to use the funds.

Let’s take a look at the three primary types of SBA loans and how they work to help you determine which loan program might be the best fit for your business.

The 7(a) Loan Program

Under the vast majority of circumstances, small business owners seeking an SBA loan start off with the 7(a) loan program. As a general purpose loan program, 7(a) loans can be used for a wide variety of business purposes, explaining why they accounted for almost 80% of the total number of loans guaranteed by the SBA in 2016.

Since the 7(a) loan program is the obvious choice for the majority of business owners, let’s dig deeper into exactly how this loan program works, who it is for, and how to proceed if you determine that this is the right SBA loan option for you.

How It Works

As with the vast majority of SBA loans, funding provided through the 7(a) loan program doesn’t actually come from the Small Business Administration. Rather, the borrowing process works very similarly to a traditional bank loan, with the only difference being that the SBA acts as a guarantor to reduce the level of risk to lenders.

Interest rates on 7(a) loans vary based on your intermediary lender as well as the size of your loan. The Small Business Administration sets a base rate as well as a maximum interest rate but lets individual lenders determine the exact rate within a given “spread,” depending upon the applicant’s qualifications and the level of industry risk facing each business.

Even so, because of the high levels of government control over interest rates for SBA loans, funds obtained through the 7(a) loan program tend to carry some of the most affordable interest rates around.

Who It’s For

Because the 7(a) loan program offers so much flexibility in its essential uses, it is far easier to narrow down the individual businesses or circumstances for which 7(a) loans are not a good fit.

If you’re looking for funds to refinance debt, reimburse a business owner for outstanding expenses, pay delinquent taxes, or buy out one of your business owners, you won’t be able to use a loan from the SBA’s 7(a) loan program for those purposes. The SBA also reserves the right to decline applications—even from qualified borrowers—when the stated use of funds does not qualify as what the SBA considers a “sound business purpose.”

Other than that? You are good to go!

General working capital. Purchasing a building or equipment. Paying the salaries of your employees until you turn a profit. Purchasing inventory or general supplies. Pretty much any expense you can think of can be covered by a loan from the 7(a) program. This is what makes the 7(a) loan program the default choice for most small business owners seeking funds through the U.S. Small Business Administration.

Steps to Apply

You can apply now through the Fundera marketplace, using the “SBA Linc” online service on the Small Business Administration website, or by directly contacting an approved intermediary lender in your area.

Want to make sure you have what you need before beginning an application? Take a look at the SBA’s 7(a) loan application checklist to review exactly what materials you need.

It’s important to note that because 7(a) loan applications require the approval of both the SBA and your individual intermediary lender, the application and approval process tends to be far more extensive than you’ll find with other borrowing options. When applying for an SBA loan through the 7(a) program, we recommend allowing for a several months-long underwriting process before you need cash in hand.

The CDC/504 Loan Program

If you need significant funds to purchase, renovate, or supply heavy equipment for a commercial real estate property for your business—or for all three of those purposes—the CDC/504 loan program could be your perfect fit.

The terms, qualifications, and arrangements of loans from this program are far more complex than the more general 7(a) loans—particularly because loans from this program are only partially funded by a traditional bank lender backed by the SBA.

Let’s clarify exactly how this program is set up so that you can determine whether it is the right choice for your business.  

How It Works

As we mentioned, CDC/504 loans have a complex structure that can be a bit difficult for business owners to understand. Under this program, typically up to 50% of project costs are funded by a bank, credit union, or non-bank lender backed by the Small Business Administration. This is the “504” portion of the loan.

On the other side, up to 40% of projects costs are typically funded a local community development corporation, or CDC. These are local organizations unaffiliated with the small business administration, and typically seek to fund loans that fit their local community development purposes, such as job creation or expansion of a particular industry or revitalization of a geographical area.

The final 10% of project costs are expected to come from the borrower, most often in the form of a cash down payment. It is important to understand that if you pursue of CDC/504 loan for your business, you are effectively seeking two separate loan—the 504 portion of the loan is an SBA loan, while the CDC portion is not controlled by SBA guidelines.

For that reason, the exact process and terms, particularly of the CDC portion of your loan, can vary widely based on your geographic area and your local community development corporation’s specific goals. That said, you can typically expect loans made available for up to $14 million for qualified borrowers with a personal credit score of at least 680. Average interest rates range from between 3.78%-4.39% with repayment terms ranging between 10-20 years.

Who It’s For

With such stringent and complex terms and high dollar amounts at stake, it is no wonder that while 504 loans account for almost 17% of total SBA-backed funds offered in 2016, they account for just over 7% of the total number of loans given. Compared with the other primary types of SBA loans, this one fits for a very small a specialized subset of Small Business Administration borrowers.

Include a CDC/504 loan among your potential options if you’re seeking a commercial real estate property for which you plan to occupy at least 51% of the space, if you’re able to provide a down payment of at least 10% of the final project cost, and if your unique business circumstances sit within the public policy goals of your local community development corporation.

This public policy aspect of the eligibility standards can be the most difficult to grasp, so we recommend checking with your local small business development center to determine whether your business will meet these standards before pursuing a 504 loan application.

Steps to Apply

Provided that you meet the criteria for a CDC/504 loan, you’ll want to connect first with a CDC in your local community to begin the application process. In some cases, your local CDC will be the one to secure your business loan. In other cases, the CDC may work in partnership with an SBA-approved lender.

Remember that if a CDC/504 loan does not turn out to be the right fit for your business, the 7(a) loan program can also be used for the purpose of purchasing commercial real estate and might be a more accessible choice.

The Microloan Program

Small businesses with very high overhead or startup costs may seek SBA loans for hundreds of thousands or even millions of dollars. But for others, the difference between small business success and being stuck in a forever rut does not necessarily require such a dramatic dollar amount. For these entrepreneurs, as little as a few thousand dollars can be all they need to take that next major step in their business.

However, since banks are already reticent to loan money to small businesses in the first place, many lending institutions won’t even entertain a business loan application for $50,000 or less. It is for exactly this reason that the SBA created the microloan program, which works with small, nonprofit intermediary lenders in local communities to fund loans of under $50,000.

These microloans carry terms of up to six years with interest rates between 8%-13%. While borrowers can obtain up to $50,00 through this program, the average size of microloans funded by the SBA in 2016 was just $14,215.

How It Works

Unlike all other SBA loan programs, the microloan program stands out as the only one in which the funds for individual loans come directly from the SBA. Nonprofit intermediaries borrow up to $5 million at a time directly from the Small Business Administration, then dole out that capital to individual borrowers according to their own qualification standards—as long as those meet the minimum qualification standards laid out by the SBA.

The exact terms and minimum requirements can vary between intermediary lenders, so you should check with your local intermediary to determine their exact application process and standards. However, you can generally expect that you will need a personal credit score of at least 640, and you will need to either put up collateral on the loan or sign a personal guarantee.

Who It’s For

An SBA microloan can be a great option for any small business owner who would see a significant positive impact on their business from capital of less than $50,000.

Although more limited than the 7(a) loan program, funds from SBA microloans can be used for a relatively wide variety of purposes, including the purchasing of materials and supplies, furniture, fixtures, inventory, equipment, labor from employees or outside contractors, or even to cover marketing and advertising costs.

However, like all other SBA programs, microloan funds cannot be used for refinancing debt. This loan program also does not qualify for the purchase of real estate.

Steps to Apply

Because the microloan approval and funding process is tightly controlled by individual SBA-approved intermediaries, you will want to check this list to find the local intermediary for your area and contact them to learn more about the application process and requirements.

That being said, as with any SBA loan, expect that you’ll need to present a well formulated business plan as well as your most recent years tax return business bank statements and the financial documents you have prepared for your business, including your most recent balance sheet, profit and loss statement, and cash flow analysis.

Despite the smaller size of SBA microloans, you can expect the application process to be equally thorough. It can take weeks or even months to hear word of your loan approval and get cash in hand. That is why it is a good idea to submit your SBA microloan application as soon as possible, long before you have an immediate need.

Also make sure you have paid close attention to detail for an organized professional application. Any errors or missing documentation only adds further delays to the process.

Applying for an SBA loan certainly requires a high level of research and organization—both of which involves an investment of your time in order to succeed. But as long as you choose the right loan program for your business, follow the proper steps to organize your loan application, and allow plenty of time for the approval and funding process, obtaining a loan through the Small Business Administration can be an excellent, low-cost capital option to move your business forward.

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