SBA Loans: 504 vs. 7(a)
In this post, we’ll examine two different types of SBA loans – 504 and 7(a). The SBA 504 loan is more challenging to qualify for and has use restrictions. Don’t discount the SBA 504 loan, though. If you need to purchase land, owner-occupied real estate, or heavy equipment, the SBA 504 loan is a viable option for you.
The SBA 7(a) loan is the most popular SBA loan program. It can be used for additional working capital, furniture, interior building updates, inventory, and other needs.
The Differences Between the 504 and 7(a) Loans:
SBA 504 loans are great for large projects, which can be up to $12.5 million with an equity injection limited to only 10 percent of the total project.
Tom Pretty, Head of SBA Lending at TD Bank, had this to say about the benefits of 504 loans:
“504 loans have many advantages including: fewer fees than other SBA products; 20-year fixed pricing on the CDC portion of the deal, which is also a below-market rate. They allow for much larger loans than the 7(a) product as there’s no official borrowing cap.”
In contrast, SBA 7(a) loans are better for company-growth. This allows for a broad range of ways to use the loan. These include:
- Startup costs
- Purchasing new land (including construction costs)
- Repairing existing capital
- Purchasing or expanding an existing business
- Refinancing existing debt
- Purchasing equipment, machinery, furniture, fixtures, supplies or materials
As you can see, the 7(a) loan does have some overlap with the 504 because of its mixed-use nature.
First, determine if your business is eligible (discussed below). Then find an SBA loan provider or broker. Next, complete all the SBA forms and submit them to your lender.
For both loan types, the business must have a strong business plan, be a for-profit business, have a demonstrated ability to pay, and relevant management experience. Below are additional requirements specific to the SBA 504 and SBA 7(a):
|SBA 504||SBA 7(a)|
|Equipment must have a 10-year minimum life.||All assets financed must be used to direct benefit of the business.|
|Business net worth of less than $15 million||Good credit (uses personal FICO score)|
|Owner occupied property (51 percent for existing construction and 60% for new)||10 percent or more down payment|
|Up to 10 percent down payment|
504 loans usually cap at $5 million but sometimes are financed up to $20 million.
Since 7(a) loans often don’t require the large capital outlay of a 504 loan, they are capped at $5 million.
It’s important to understand that there is a limitation of SBA dollars available as loans. Also, choosing the right loan for a specific purchase will result in optimal use of available SBA dollars.
The 504 loan doesn’t use as many SBA dollars as the 7(a) loan. For example, where a 504 loan might only use 40 percent of SBA dollars, a 7(a) will use 75 percent. This means when you utilize a 7(a) loan, you use up more SBA dollars than with a 504 loan.
That’s why using a 504 loan for large real estate or equipment related purchase is optimal use of SBA dollars. On the other hand, paying for inventory through a 7(a) is the best use of SBA dollars for those types of purchases.
504 loan terms are 20 years for real estate and 10 years for equipment. 7(a) loans terms are up to 25 years on real estate and up to 10 years on business acquisition and equipment. Additionally, 7(a) loans have 5 to 7-year terms for working capital and a weighted average for mixed-use request.
Both loans require personal guarantees and collateral. Prepayment penalties also come with both loans, which decline depending on the age of the loan and amount prepaid.
Fees on a 504 loan will not rise as the loan amount rises, which can happen with a 7(a) loan. The 7(a) loan includes an additional .25 percent charged to loan portion above $1 million.
The 504 loan does include servicing and legal fees but generally has lower overall fees than 7(a) loans.
Which Loan Is Right for Your Business?
In general, the 504 loan is oriented toward commercial real estate and equipment. The 7(a) loan is for mixed-use or general purpose.
If you need a business loan for working capital, inventory, or for general flexibility of use, the 7(a) loan will do the job. For land and heavy equipment purchases, the 504 is your go-to loan.
Have you utilized either of these financing options? Tell us about your experience in the comment section below.
Editor’s Note: This post was updated for accuracy and comprehensiveness in January 2019.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.