SBA 504 Loan: What It Is & How It Works
504 loans offered through the Small Business Administration (SBA) are designed to provide funding for fixed assets that help in the creation of jobs or business growth. Some examples of allowable uses include the purchase or construction of land, buildings, machinery, and other equipment.
An SBA 504 loan has two separate funding sources: Certified Development Companies (CDCs) provide 40% of the funds, while an SBA-approved lender provides 50%. The remaining 10% comes as a down payment from the borrower. The program typically allows for a maximum financing amount of $5.5 million.
Who Should Get an SBA 504 Loan
An SBA 504 loan can provide financing opportunities for eligible borrowers who plan on using it to acquire fixed assets for their business, which will promote job creation and business growth. To determine whether or not it suits your business needs, the following are its allowable and prohibited uses:
The SBA specifically prohibits funds from being used for the items listed above. If your business needs aren’t allowable, you can consider an SBA 7(a) loan.
Summary of SBA 504 Loan Rates, Terms & Qualification Requirements
An SBA 504 loan is uniquely structured in that it can technically be viewed as two loans in one. This is because it’s provided by both a lender and a CDC, which means you’ll have to review loan details such as rates, terms, and qualifications for each set.
For instance, you’ll be paying two separate interest rates on your SBA 504 loan—one for the CDC portion and the other for the lender’s portion. Similarly, SBA 504 loan qualifications will be a combination of what the SBA requires and a lender’s own eligibility criteria.
SBA 504 Loan Rates
You’ll pay two differing interest rates on an SBA 504 loan: both the CDC portion and the lender’s portion.
SBA 504 Rates on the CDC Portion
SBA 504 loan rates on the CDC portion of the loan can change every month. You can view the latest rates below or in our guide on current SBA loan rates for all SBA loan programs.
SBA 504 Loan Rates on the Lender Portion
In addition to the rate you pay on the CDC portion of your SBA 504 loan, you’ll also pay a separate interest rate on the lender portion of the loan. That interest rate will vary depending on the provider you choose but typically ranges from 6% to 15%.
Loan fees will apply to both the CDC and lender portions of the loan. As is the case with rates, lender fees can vary depending on the provider you choose, your qualifications, and the loan terms you’re seeking.
SBA 504 Loan Fees for the CDC Portion
The SBA 504 loan fees you pay could be impacted by several factors unique to your loan. However, federal regulations do exist—and they impose limitations on the type and amount of fees that can be charged. You can view these regulations online, but they generally include the following:
- SBA guarantee fee: 0.5% of the total value of the loan
- Processing fee: No more than 1.5% of the 504 portion of the loan
- Closing fee: Varies depending on loan amount
- Monthly servicing fee: 0.625% to 2% of the loan balance, calculated at five-year intervals; up to an additional 1.5% may apply in extenuating circumstances if deemed necessary to cover related loan costs
- Funding fee: Not to exceed 0.25%
- Participation fee: 0.5% on the lender’s share, plus up to 1.5% of the CDC portion
To reduce your upfront costs, fees can often be included with your loan. And although the fees mentioned above may seem excessive, they will usually total around 3% of your total loan amount.
SBA 504 Prepayment Penalties
Another type of fee that applies to SBA 504 loans is a prepayment penalty. For a 10-year loan, the penalty applies for the first five years. For a 20- or 25-year loan, the prepayment penalty applies for the first 10 years.
To calculate the dollar amount of your prepayment penalty, you’ll need to know your loan’s debenture rate. The debenture rate is different from the rate you get on the loan and reflects the portion of the loan that your CDC is paying investors in exchange for a portion of the funds needed to issue the SBA 504 loan. Debenture rates can vary from month to month.
Below are two examples of the prepayment penalty you might see on a 10-year loan and a 25-year loan.
SBA 504 Loan Fees for the Lender Portion
Lender fees on an SBA 504 loan will vary considerably depending on the practices and required qualifications of the lender. Although there aren’t any restrictions on what a lender can charge, fees are still almost always more competitive than most other types of loans.
SBA 504 Qualification Requirements
Qualifying for an SBA 504 loan requires meeting eligibility criteria from both a lender and SBA-specific requirements.
SBA Requirements
Eligibility criteria for SBA 504 loans include the following items:
- You must operate as a for-profit company based in the US.
- You must have a tangible net worth that does not exceed $15 million.
- Your average net income for the past two years must not exceed $5 million.
- You must adhere to the requirements listed on the SBA website for SBA size standards.
- You must have a minimum down payment of 10%.
- You must not be delinquent on any federal debt (this includes federal student loans).
- If acquiring real estate, the property must be at least 51% owner-occupied.
- Assets being acquired must support job or business growth.
- You must have a satisfactory business plan and character and the ability to repay the loan.
Our related resource: How to Write an SBA Business Plan [+Free Template]
These requirements may have exceptions in certain circumstances. For example, the SBA does not specify all of the items that must be met for a business to document a sufficient ability to repay a loan. Rather, the SBA allows individual lenders to establish many of these criteria.
Lender Requirements
In addition to the SBA-specific requirements, lenders can implement their own set of eligibility criteria. Here are some general criteria that lenders may take into consideration:
- Personal credit score: Some lenders may take into account your personal credit score when determining your creditworthiness as a borrower. Generally, the stronger the score, the better. We recommend a score of 680 and above for greater odds of approval.
- Business credit score: Lenders will likely place more value on your business credit score to learn more about your track record and financial stability as a borrower.
- DSCR: You can calculate this figure by taking your company’s net operating income, and then dividing it by your current year obligations. A DSCR of 1.25× or greater is what most lenders will be looking for. You can also use our calculator in our guide on Debt Service Coverage Ratio.
- Time in business: While some companies do work with startups, it can be much easier for you to get an SBA 504 loan with a minimum of two years’ time in business to prove that you’re an established borrower with sufficient cash flow.
- Down payment: SBA 504 loans require a minimum 10% down payment, but you may want or need to place a larger amount depending on your qualifications, loan terms, and lender. This requirement can fluctuate depending on the collateral offered and the cash flow of your business.
SBA 504 Loan Pros & Cons
How to Get an SBA 504 Loan
To get an SBA 504 loan, there are a few applicable steps you need to take to ensure your eligibility and that the application process goes smoothly. You’ll need to consider your loan options and qualifications, find and choose a participating lender, and submit your application and supporting documentation.
We summarize each of these steps below, but you can also head over to our guide on how to apply for an SBA loan for more details on each stage.
Before deciding on an SBA 504 loan, ensure you’ve evaluated all your financing options—including the various SBA loan programs. There are several different types of SBA loans available, each with its own set of terms, qualification requirements, and allowable uses. Once you’ve decided on the type best suited for your business needs, your next step will be to review your SBA loan eligibility.
SBA lenders will evaluate your application to determine if you can be approved. However, doing your own due diligence before applying and understanding how you’ll be evaluated can allow you to better present your business in a manner that improves your chances of approval.
SBA requirements can be broken down into three categories: general SBA requirements, loan-specific requirements, and lender-specific requirements. Before proceeding with an application, ensure you meet the basic requirements for each of these categories.
You’ll need to find a participating lender that has been vetted by the SBA. Applicable lenders can include banks, credit unions, brokers, and online lenders.
You can start with our list of the best SBA lenders. The SBA website also provides a tool called Lender Match, which can provide you with lender options based on your business needs.
Once you’ve chosen a lender, you’ll need to prepare and submit a formal loan application. Keep in mind, SBA loans are known to require a significant amount of paperwork, so be prepared to furnish any supporting documentation requested by the lender. To help you prepare, you can read our guide on how to get a small business loan for more insight on the application process.
Such documents to prepare may include the following:
- Tax returns
- Profit and loss statements
- Balance sheets
- Business plan (see our SBA business plan guide and template)
- Business licenses and relevant professional certifications
- Net worth statements
- Bank statements
SBA 504 Loan vs Alternatives
Commercial real estate loans can be a viable alternative if you find that an SBA loan is not the right fit. If this is the case with your business, consider viewing our recommendations for the best commercial real estate loans.
Frequently Asked Questions (FAQs)
An SBA 504 loan is a government-backed loan program that can be used to finance major fixed assets that can help promote the creation of jobs or the growth of a business. Examples include the construction of new office buildings or production facilities and the improvements to land.
Yes, it is. You may see these terms used interchangeably—but they refer to the same loan program. SBA 504 loans consist of two loans: one portion is funded by a Certified Development Company (CDC), while the other portion is funded by an SBA-approved lender.
There are various qualification requirements imposed by the SBA and the participating lender of an SBA 504 loan. This is dependent on the complexity of your business needs, your creditworthiness as a borrower, your loan application, how quickly you can provide documentation to your lender, and the length of time needed for your lender to conduct its own due diligence and verifications.
Bottom Line
Getting an SBA 504 loan to finance your business can be beneficial if you’re looking to make a real estate investment or obtain capital for other business purposes. SBA 504 loans have competitive rates in comparison to other conventional loans but have strict qualification requirements and come with a lengthy process in terms of obtaining the loan. However, they can be worth the effort to get favorable rates, long repayment terms, and high loan amounts.
