- FundingTrail
- Sep 8
- 6 min read
Updated: Sep 10
If you own a small business and need funding, it's important to consider all of the options available to you. SBA (Small Business Administration) loans can be a great lending option for those companies that meet certain criteria.
How Do SBA Loans Work: What to Know About SBA Loans
SBA loans are business loans partially guaranteed by the U.S. Small Business Administration and issued by participating lenders, usually banks. They are very similar to traditional bank loans, but the SBA guarantee means they will often have more favorable financing terms than a comparable bank loan.
What Can SBA Loans Be Used For?
Loans may be used for multiple business reasons, including working capital funding, the purchase of new equipment or real estate, and to invest in the ongoing operations of a business.
SBA loans are desirable by many companies because they offer longer repayment terms and lower interest rates than many other business loans do. When you're considering what to know about SBA loans, understand that the application process can be lengthy and funding typically requires at least 60 to 90 days.
How Do SBA Loans Work?
In some ways, SBA loans work like conventional business loans. You apply through a lender, and if approved, you’ll receive funds that must be paid back at fixed intervals. The difference with an SBA loan is that the lender then applies to the SBA for a loan guarantee. The loan guarantee means that if you default on an SBA loan, the government pays the lender the guaranteed amount.
The SBA also requires a personal guarantee from everyone with at least 20% ownership in a company. This guarantee puts you and your personal wealth on the hook for payments if your business can't make them.
Once you’re approved for an SBA loan, your lender is responsible for closing the loan and disbursing the loan proceeds. You repay the lender directly, usually on a monthly basis.
What are the Different Types of SBA Loans?
Let's take a look at each of the three main SBA loans in a little more detail.
7(a) Loans
7(a) loans are the most common type of SBA loans and the most flexible. They can be used to purchase business real estate, meet working capital requirements, refinance current business debt, purchase equipment, or even purchase an established business. 7(a) loans can be granted for up to a maximum of $5 million.
Interest rates for 7(a) loans are negotiated between the borrower and the lender, but are subject to SBA maximums. These maximums are pegged to the prime rate — a benchmark used by banks to dictate rates on consumer loan products, which changes based on actions by the Federal Reserve — plus a spread that is negotiated between you and your lender.
The maximum interest rates for variable 7(a) loans are as follows:
Repayment terms on 7(a) loans vary. For loans used to purchase equipment, repayment terms are allowed up to a period of 10 years. If the loan is used to purchase real estate, repayment may be extended to a period of 25 years.
The vast majority of US businesses are eligible for SBA loans, but some are not. Eligibility requirements for a 7(a) loan include:
Business must operate for profit
Conduct business within the United States
Be "small" under SBA Size Requirements
Not be a type of ineligible business
Not be able to obtain the desired credit on reasonable terms from non-government sources
Be creditworthy and demonstrate a reasonable ability to repay the loan.
Not be delinquent on any other loans to the U.S. government
504 Loans
The 504 loan program provides long-term, fixed-rate financing of up to $5.5 million for major fixed assets that promote business growth and job creation.
In other words, 504 loans are for buying big, physical stuff. You can't use a 504 loan to buy a desktop printer. But if you're starting a publishing business you could use a 504 loan to buy a printing press and a warehouse to store all your books.
The biggest advantages of the 504 program are the relatively low interest rates and the low down payment required for such a large loan.
In a 504 loan, a bank provides 50% of the loan amount, an SBA-approved certified development company (CDC) provides 40% of the loan amount, and the borrower provides a down payment for the final 10%.
How it works:
Thought the 504 program you effectively receive two loans bundled into one package
Your bank will handle their 50% of the loan and will negotiate with you directly for the interest rate on this portion.
The SBA CDC will will issue their 40% of the loan with an interest rate set nationally. The broader SBA has a monthly debenture pricing which sets the rate for all CDC 504 loans issued that month. This interest rate will be equal to the 5 to 10 year Treasury rate plus 2.23% to 2.39%, depending on the repayment terms of the loan.
You will make two separate monthly payments, one to your bank and one to the CDC.
Repayment terms on a 504 loan can be over either 10, 20, or 25 years.
Example
The structure can seem a little complicated so let's look at an example below. The terms shown below are for a 504 loan to purchase a $1,000,000 building for commercial use.
Eligibility Requirements
A company must be able to show the following to be eligible for a 504 loan:
That it operates as a for-profit company within the United States
That it has a tangible net worth of less than $20 million
That it earned a net income of less than $6.5 million after taxes during the prior two years
SBA Microloans
Microloans are the smallest funding option offered by the SBA. The microloan program provides up to $50,000 to businesses seeking to start up or expand. They can be used for working capital or expansion costs but cannot be used to refinance existing debt or to purchase real estate.
The loans are funded by the SBA but issued through intermediary not-for-profit lenders. Microloans are designed to provide financing to traditionally underserved businesses, including startups and businesses located in low-income communities.
Interest rates for microloans vary based on the intermediary lender but are generally between 7% and 13%. Repayment terms vary and are based on the amount of the loan, what it is used for, and the needs of the borrower. However, the repayment term may not exceed seven years.
SBA microlenders usually require collateral for microloans. If you take out a microloan to purchase physical assets, those assets and be used as collateral for the loan. Microlenders will usually require a personal guarantee of the loan as well - making you personally liable to repay the loan if your business cannot make payments.
The Good and the Bad of the SBA
Pros of SBA Loans
When you're considering financing, it is important to understand the pros and cons of SBA loans. Some of the pros include:
Low Interest Rates
Interest rates for SBA loans are generally much lower than those given by commercial banks or other traditional lenders.
Long Repayment Terms
Depending on the type of loan acquired, repayment terms can be as long as 25 years.
Usable for a Variety of Purposes
What can SBA loans be used for? SBA loans may be utilized for a number of different purposes, including working capital, to purchase equipment or real estate, or otherwise invest in the growth of a business.
Small Down Payment
An SBA loan doesn’t always require a down payment, but when they do, they are typically much less than a commercial loan.
Cons of SBA Loans
While SBA loans may sound great, they do have some downsides, including:
Lengthy Application Process
Applying for an SBA loan is a long process that requires lots of documentation and time to put together.
Difficult to Qualify For
To access most SBA loans, you must have at least a few years in business, strong annual revenue, and excellent personal credit.
While the pros and cons of SBA loans vary, in general, you can expect a lower cost of financing than more traditional business loans.
How to Apply for an SBA Loan
To apply for an SBA loan, you will need a variety of different documents. These include business financials for several years, both business and personal tax returns, and a business plan.
The best place to start is the SBA's Lender Match Tool. Just answer a few questions about your business and lending needs, then the online tool will provide you a list of SBA partner lenders that offer the type of loan you're looking for. The government rarely makes things easy or user-friendly but they nailed it with Lender Match.
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