January 28, 2019

Pros and Cons of SBA 7(a) Loans

Since the SBA encourages the growth of small businesses rather than producing profits, its loan programs are often more affordable and accessible than traditional bank loans. However, there are some important drawbacks to consider prior to submitting your application. To help you determine if SBA 7(a) loans are right for your business plan, we’re going to review the pros and cons of this working capital option. Let’s get started.

Pros of SBA 7(a) Loans:

1. Easier to Secure Than Traditional Loans

Key Takeaway: Because there's less risk involved, SBA lenders are more likely to approve your application for this type of small business loan. When you apply for an SBA loan, you’ll apply through a traditional bank, not the government. However, the government guarantees 75 to 85 percent of the loan, thereby reducing risk for SBA lenders. As a result, many banks will approve SBA 7(a) loan applications that they would’ve ordinarily rejected for traditional financing options. This can be beneficial if your business finances or personal credit score are preventing you from qualifying for other types of funding, such as a line of credit, credit card, or traditional loan.

2. Lower Interest Rates

Key Takeaway: The SBA sets a reasonable maximum interest rate, ensuring that loans are affordable to small business owners. The SBA stipulates maximum interest rates for their loan programs, because they want small business owners to be able to afford their options. Currently, the maximum interest rates for this SBA loan product ranges between 7 and 9.5 percent, depending on the loan amount and terms. For a business loan, these interest rates are quite affordable. However, lower interest rates can sometimes be secured with traditional loans.

3. Lenient Down Payment Requirements

Key Takeaway: SBA 7(a) loans require a down payment of just 10 percent. Often, lenders want to see you put some of your own money towards your investment. This gives you a financial stake in your project and ties your interests directly to your business’ success. As such, many lenders require a 20 percent down payment. However, lenders will often accept down payments of just 10 percent with SBA 7(a) loans. This allows you to preserve your personal cash while reducing the burden a down payment can put on your business's cash flow.

Cons of SBA 7(a) Loan

1. Lenders Have a Lot of Discretion in Setting Loan Terms

Key Takeaway: While the SBA does set some rules, approved lenders still have a lot of leeway in both approving and structuring loans. Many of the benefits we outlined above are subject to the discretion of the lender. Although there are maximum interest rates, some lenders might charge less, while others will charge the full rate. In addition, some lenders may ask for a higher down payment or will cover a smaller portion of the loan. Further, lenders often charge higher fees for SBA 7(a) loans than typically charged for private loans.

2. Personal Collateral May Be Required

Key Takeaway: You’ll likely have to use personal assets or valuable business assets as collateral, greatly increasing your risks. Putting liens on property is standard for the SBA. If you have valuable assets, your lenders may ask that you put those assets forward as collateral. For example, a lender may require that your house or business real estate be tied to the loan. If you default, the SBA could seize your property.

3. The Application Process Can Be Strenuous

Key Takeaway: You’ll have to apply to individual lenders, and your credit score will be evaluated. When you receive this type of loan, you’re receiving loan directly from a lender. The government guarantees but doesn’t provide the loan. As such, you’re going to have to complete each lender’s application process, which may vary. In fact, SBA 7(a) loans take an average of 45 days to approve. Plus, lenders will look at your credit history very closely when evaluating your application. While lenders have a lot of discretion and can set their own eligibility requirements, you’ll often need a score of 620 or higher. Therefore, if your personal or business credit aren't high, this could affect your ability to get approved.

Conclusion: SBA 7(a) Loans Are Great, but Come with Drawbacks

This type of SBA loan program is among the best financing sources for small businesses. They’re affordable, typically come with generous terms, and can be easier to obtain than traditional loans. However, that doesn’t mean they’re perfect. Other business funding sources may be more affordable, with easier, faster application processes and more lenient prerequisites. It's important to note that you won't get approved for an SBA loan if you can't prove that you've been declined for other types of financing, so you may need to pursue these options first. Either way, when evaluating funding opportunities, you should carefully consider both the benefits and drawbacks. Hopefully, after reading this post, you should be able to decide if this type of loan is worth pursuing. Editor’s Note: This post was updated for accuracy and comprehensiveness in January 2019.