Comparing Types of SBA Loans: 7(a) vs. 504

Small businesses are the backbone of the U.S. economy, creating jobs, fostering innovation, and supporting local communities. Yet, small businesses often face difficulties accessing capital, which may hinder their growth and development. That’s where the Small Business Administration (SBA) comes in. The SBA was created to help ensure that small businesses have the tools and resources they need to start and expand their operations and create jobs that support a growing economy and strong middle class.

One key area in which the SBA helps small businesses is through SBA-backed loans. The two most popular loan programs offered by the SBA are the 7(a) loan and the 504 loan. Both the 7(a) and 504 loans are federally backed loans that are designed to help small businesses access the capital they need to grow and thrive; however, when considering their financing options, business owners should be aware of some key differences between the two.

7(a) Loan

The 7(a) loan is the SBA’s flagship loan program and is designed to provide funding to small businesses that are creditworthy but cannot otherwise qualify for conventional bank loans. The 7(a) loan is a general-purpose loan that can be used by borrowers for almost any legal business purpose. Loan proceeds can be used to purchase and/or improve real estate, equipment, and inventory or provide working capital. The loan may also be used to refinance business debt, purchase an existing small business or franchise, and even finance partner buyouts.

The SBA 7(a) program offers several loan options ranging up to $5 million, with terms that extend to 25 years. Interest rates are predominately variable (with some fixed-rate options), are generally based on the Prime rate, and the SBA places a cap on the maximum amount of interest lenders can charge. SBA 7(a) loans come with fees up to 3.75% of the guaranteed portion, but fees can be financed within the loan itself. Since the SBA prefers to work with borrowers who are willing to invest equity in their own operations, the minimum borrower down payment is 10% (but is often 20% – 30%). Collateral may also be required for loans in excess of $350,000, but lenders are not required to take collateral for loans under $25,000. If business fixed assets do not “fully secure” the loan, the small business owner may need to offer another form of collateral, such as a personal residence or other property.

504 Loan

The SBA 504 Certified Development Company (CDC) loan program is specifically designed to help small businesses purchase long-term fixed assets—usually real estate or large equipment—for expansion or modernization. Refinancing of large equipment and/or owner-occupied commercial real estate may also be possible. However, loan proceeds cannot be used to purchase inventory, refinance or retire debt, or as a source of working capital.

Aside from the different purposes of the loans, one of the biggest differences between the SBA 504 and 7(a) loans is that 504 loans have fixed interest rates—tied to the current five- and 10-year U.S. Treasury rates—for the life of the loan. SBA 504 loans are generally capped at $5 million, and borrowers can choose from 10-, 20-, and 25-year repayment terms. SBA 504 loans are structured as two-part loans with 50% of the funding coming from a bank or credit union and 40% coming from a CDC. The remaining 10% will be contributed by the small business owner as a down payment. A range of fees are charged in the 504 loan process, but fees are usually rolled into the loan to limit the business owner’s upfront cash contribution requirements. With 504 loans, the project being financed (e.g., the purchase of real estate or equipment assets) is typically used as the collateral. However, personal guarantees are required for any person who owns more than 20% of the business.

Here’s a quick breakdown of the major differences between SBA 7(a) and 504 loans: