The SBA 504 loan program combines two loans―one from a lender, one from a community development corporation (CDC)―that can be used for commercial real estate, and other fixed assets like equipment. The lender portion covers up to 50% of the loan, the CDC portion covers 40%, with the borrower providing the remaining 10%.
What an SBA 504 Loan Is
SBA 504 loans are commercial real estate loans and are comprised of two loans, one from a traditional bank and one from a nonprofit lender, known as a CDC. SBA 504 loans are available up to $14 million, with terms up to 20 years, and at interest rates that are lower than those offered by traditional banks.
Here is a brief comparison of SBA 504 loans, other SBA loans, and traditional commercial real estate loans.
Loan Options for Commercial Real Estate: SBA 504 vs SBA 7(a) vs Traditional Loan
|Collateral Other Than Real Estate|
|Amount You Can Borrow|
|Minimum Credit Score|
(check yours for free)
What SBA 504 Loans Can Be Used For
An SBA 504 loan can be used to purchase land and existing buildings, to pay for property improvements and renovations, or to build a new facility. Additionally, SBA 504 loans can be used to finance other fixed assets, such as equipment and machinery, or to refinance debt that was used to acquire fixed assets.
Under the SBA loan rules, CDC/SBA 504 loans can be used for these specific purposes:
- Buying land and existing buildings on the land
- Paying for property improvements like adding parking lots, connecting utilities, and even landscaping
- Renovating an existing property inside the building
- Building a new facility or improving a facility
- Buying other fixed assets, such as long-term equipment and machinery
- Refinancing debt; made permanent on June 24, 2016, the SBA 504 refinance loan applies to debt that was primarily incurred (85%+) to acquire a fixed asset eligible under SBA 504 loan rules; the existing debt must be at least two years old and in good standing
An SBA 504 loan combines two different loans that are closed at the same time, one from a lender and one from a CDC. These loans can be used to purchase commercial real estate, but that’s not the only use of an SBA 504 loan.
According to Andrea Roebker, regional communications director of the SBA:
“A 504 loan is designed to assist with fixed assets, including the purchase or construction/renovation of real estate, as well as the purchase of long-term machinery and equipment.”
When looking for funds for one of these loan purposes, we recommend working with Liberty SBF to get an SBA 504 loan. If you have a credit score above 680, you’ve been in business at least three years, are profitable, and need more than $1 million, speak with Liberty SBF today to see how much you might qualify to receive.
What SBA 504 Loans Cannot Be Used For
SBA 504 loans are great for commercial real estate, but there are a number of uses of the loan funds that are prohibited. These loans cannot be used to fund working capital, inventory, normal operational expenses, or for marketing expenses. Additionally, SBA 504 loan funds cannot be used for rental properties or speculative real estate investments.
Some of the restricted uses for SBA 504 loans are:
- Working capital
- Materials, supplies, or inventory
- Advertising or marketing
- Normal operational expenses
- Speculative real estate investments
- Rental properties
If you need an SBA loan for any of the purposes prohibited under SBA 504 loan rules, read our article on SBA 7(a) working capital loans. An SBA 7(a) loan is very flexible in its uses and can be used in conjunction with an SBA 504 loan. SmartBiz has the fastest funding times that we have seen for SBA 7(a) loan under $350,000. Plus, they can prequalify you in minutes.
Top 4 Benefits of an SBA 504 Loan
The SBA guaranteed over 27% more in loan funds for 504 loans in 2018 compared to the amount guaranteed in 2017. The increase in popularity among borrowers is due to the great advantages an SBA 504 loan can give to borrowers. These benefits include low SBA 504 loan rates, low down payment requirements, and lengthy repayment terms. Additionally, SBA 504 loans do not require any additional collateral beyond the property being financed.
The four primary benefits to getting an SBA 504 loan are low interest rates, low down payment, long repayment terms, and no additional collateral.
1. Low Interest Rates
Interest rates for the CDC portion of the loan are limited by the SBA and currently range between 4% and 5%. That rate is fixed and will not increase for the life of the loan. The bank’s loan doesn’t have these limitations. The rates typically fall between 5% and 10% and can be either fixed or variable.
2. Low Down Payment
While most traditional commercial loans require a 20% to 40% down payment, an SBA 504 loan requires a down payment as small as 10%. If your business is a startup or the property you want to buy is a single use building, you will need a 15% down payment. The down payment requirements increase to 20% for startups purchasing single-use properties.
Even if you are operating a startup business, and you’re purchasing a single use building, the 20% down payment requirement with the SBA 504 loan is advantageous. As a startup, many traditional lenders may be hesitant to offer financing and, if it was offered, it would likely involve a much larger down payment.
3. Long Repayment Terms
While most traditional commercial mortgages are five to 10-year loans, the CDC portion of an SBA 504 loan has a 10-year term for equipment and a 20-year term for real estate. The bank portion of the loan typically has a seven-year term for equipment and 10-year term for real estate. The longer repayment term offered on the CDC loan reduces the monthly payment, thereby making the payments more affordable.
4. No Additional Collateral
Generally, the real estate or other fixed assets being financed by the SBA 504 loan are sufficient collateral, and no additional collateral will be required. With no additional collateral required beyond the real estate or fixed assets you are financing, your remaining assets remain lien free. As such, should you need to use them as collateral for another loan, you will be able to do so.
We asked the head of SBA lending at TD Bank, Tom Pretty, his thoughts on the benefits of getting a 504 loan. He says:
“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 is no official borrowing cap―TD Bank, for instance, has done some 504 loans of $20 million or more―and 504 loans have no additional collateral requirement.”
The low interest rates, long repayment terms, and the freedom of not having to provide additional collateral make SBA 504 loans a practical financing choice for qualified borrowers.
SBA 504 Loan Qualifications
In many ways, qualifying for an SBA 504 loan is similar to qualifying for a traditional commercial real estate loan. You will need to have a credit score of at least 680, a debt service coverage ratio of at least 1.25x, and a down payment of at least 10%. Additionally, you will need to be able to demonstrate repayment ability and have a clean financial history.
Some of the basic qualifications include:
- Credit score: At least 680 (check your score for free)
- Debt service coverage ratio (DSCR): At least 1.25x. You can calculate your DSCR by dividing your annual net income by the sum of the annual principal and interest payments on your loans (the subject SBA 504 loan and any other existing debt obligations).
- Down payment: At least 10% to 20% of the combined CDC/SBA loan amount
- Clean financial history: There should be no recent bankruptcies, foreclosures, or tax liens in your recent personal or business financial history
In addition to the general SBA loan requirements, the SBA 504 loan program requires:
- Net worth less than $15 million: Your business must have a tangible net worth less than $15 million and an average net income less than $5 million after taxes for the last two years.
- At least 51% owner occupancy: Existing buildings must be at least 51% owner-occupied. The same is true if a loan on an existing property is to be refinanced. For new construction, the building must be at least 60% owner-occupied upon occupancy but gradually increasing to 80% owner-occupied by year 10.
- At least 10-year equipment life: Any equipment purchased with the funds must have at least a 10-year economic life, which rules out things like computers, software, and so on.
- Use of funds must create jobs or enhance SBA goals: You must show how the loan will help create new jobs or enhance public policy goals. For example, you can make existing facilities more energy efficient or increase your production of renewable energy.
The two key additional SBA 504 loan requirements are that the property must be owner-occupied, and jobs must be created.
1. Property Must Be Owner-occupied
You must be eligible for the SBA 504 program, and the property you are purchasing must be as well. For the property to meet the SBA 504 requirements, it must be at least 51% owner-occupied. You can rent out part of the building but must be using the majority of it for your business. If you’re constructing a building, it must be at least 60% owner-occupied at initial occupancy and increase over the next ten years to 80% owner occupancy.
2. Jobs Must Be Created
The purpose of the SBA 504 loan program is to encourage job creation and economic development. As part of the loan process, you will need to explain how your use of the loan proceeds will create or retain jobs that would otherwise be lost, or how you’ll support public policy goals. Currently, the rule is that one job must be created or retained for every $65,000 of funding. This increases to one job per $100,000 borrowed for small manufacturers.
In lieu of meeting job creation goals, you can also qualify for an SBA 504 loan by enhancing other public policy goals, such as energy conservation and supporting minority business development. The SBA’s website provides a more detailed breakdown of the different public policy goals that your project can meet.
SBA 504 loans are suitable for projects large and small. However, most banks prefer to provide SBA 504 loans for projects of more than $500,000. This is primarily because the amount of effort required to close a 504 loan is significant, and lenders are hesitant to pursue projects unless their payout is big enough. For the lender, loans of less than $500,000 begin to mean a lot of work for a very small payout.
SBA 504 Maximum Loan Amount
Current SBA rules set the maximum amount you can borrow with an SBA 504 loan is about $14 million. However, due to restrictions on the use of proceeds and qualifying projects, the amount your project qualifies might be lower. In 2018, 48% of all SBA 504 loans funded projects in the range of $350,000 to $2 million.
SBA 504 Loans by Loan Amount for Fiscal Year 2018
The vast majority of SBA 504 loans made in fiscal year 2018 went to fund loans in amounts ranging from $150,000 to $2 million. While SBA 504 loan amounts can extend up to $14 million, this indicates that loans in this amount are not common.
A breakdown of the number of SBA 504 loans by loan size looks like this:
Source: SBA 504 Loan Data
SBA 504 Loan Rates and Fees
With an SBA 504 loan, you can expect to pay low interest rates and minimum fees. In general, interest rates on the bank portion of the loan will range from 5% to 12% APR. The rates for the CDC portion of the loan are fixed and typically range from 4.5% to 6%APR.
Remember, however, there are two loans made as part of an SBA 504 loan that you must pay interest on. The first is a loan from a traditional lender, like a bank. The rates, terms, and fees for that portion of the deal up to 50% have very few restrictions. As such, they can vary widely from borrower to borrower. With a little negotiation, most people find the commercial real estate loan rates and terms for this portion of the deal to still be very favorable compared to other financing options.
The second part of the loan is issued by the CDC. The rates, terms, and fees for this portion of a 504 loan are heavily regulated. The CDC loan is a 10- or 20-year, fully amortizing, fixed-rate loan. It works the same way as a traditional mortgage loan. The borrower pays equal monthly payments for the life of the loan, at which point the loan is completely paid off.
SBA 504 Loan Interest Rates & Fees: CDC Portion of the Loan
The typical rates and fees for the CDC portion of the SBA 504 loan range from 4.5% to 6% of the loan amount. The total costs of this portion of the loan are comprised of the interest rate, the CDC servicing fee, the SBA guarantee fee, and the servicing agent fee.
Summary of Rates & Fees on the CDC Portion of the SBA 504 Loan
|Annual Fees and Interest Rates|
|CDC Servicing Fee|
|Central Servicing Agent Fee|
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The various fees you will encounter with an SBA 504 loan are:
CDC Portion of the SBA 504 Loan: Monthly Servicing Fees
The CDC portion of the SBA 504 loan comes with monthly servicing fees. The monthly servicing fee is comprised of the ongoing SBA guarantee fee, the servicing agent fee, and the CDC fee.
SBA Guarantee Fee
This is an ongoing SBA Monthly Guarantee fee presently equal to 914/1000s of one percent per annum (.914 of 1.0%) of the principal balance of the note, calculated at five-year intervals, beginning with the first payment. The Central Servicing Agent (Wells Fargo) receives 3/64th of this fee and must remit the remainder to the SBA.
Servicing Agent Fee
The Central Servicing Agent (presently Wells Fargo) fee of one-tenth of one percent per year (0.10%) is added to the outstanding balance of the Note. It is calculated at five-year intervals, beginning with the first payment. The administrative fee goes to Central Servicing Agent (Wells Fargo) for processing and recording loan payments. At 0.1% of the loan value, it’s not a significant portion of the cost. The SBA fee compensates the SBA for the risk of the loan defaulting.
There is a CDC Servicing Fee of five-eighths of one percent (0.625%). The CDC MUST retain at least 0.5% of this fee as required by SBA regulations and policies. In addition, from this servicing fee, CDCs must pay one-eighth of one percent (.125%) to SBA each month. Per SBA regulations, the minimum CDC servicing fee can be 0.625% per year, and a maximum of 2% per year. For rural areas, the maximum is 1.5% per year.
The CDC fee goes toward supporting the operation of the CDC, with the minimum and maximum fee set by the SBA. However, the individual CDC has the discretion to set the fee within these limits.
CDC Portion of the SBA 504 Loan: One-time Fees
When the loan is initially made, there are some initial “one-time” fees associated with obtaining an SBA 504 loan. These are one-time only expenses that are financed along with the debenture (meaning they can be wrapped into the loan and amortized over the life of the loan). These costs typically amount to 2.5% to 3.0% of the loan’s value.
Common one-time costs include:
- Underwriting fee: 0.375% to 0.4%
- Processing fee: Up to 1.5%
- Legal fee: $2,000 to $5,000
- Funding fee: 0.25%
- Guarantee fee: 0.5%
While all of these fees may seem overwhelming when you look at them individually, even with all of the fees included they only amount to 2.5% to 3% of the value of your loan.
CDC Portion of the SBA 504 Loan: Prepayment Penalty
Prepayment penalties are common with commercial real estate loans, but might they may come as a surprise to businesses shopping for an SBA 504 loan. Luckily, the prepayment penalty for an SBA 504 loan is easy to calculate and also relatively small. The prepayment penalty is only applicable during the first half of the loan term, with the maximum penalty being equal to the debenture rate at the time of the loan.
The prepayment penalty is assessed on the CDC portion of the SBA 504 loan if the loan is prepaid during the first half of the loan’s term to maturity. The prepayment penalty is calculated on a sliding, decreasing scale. The penalty is figured on the debenture interest rate (at the time the loan was issued), not the effective interest rate of the loan.
For a loan with a 20-year maturity, the penalty applies to the first 10 years of the loan and decreases by 10% each year. For a loan with a 10-year maturity, the penalty applies to the first five years of the loan and decreases by 20% each year.
Example: Assume when a 20-year loan was issued, the effective interest rate for the month of August 2016 is 4.960%, and the debenture interest rate is 2.880%. The prepayment penalty declines by 10% of the debenture rate each year; in other words, it drops by a factor of .288% each year.
SBA 504 Loan: CDC Prepayment Penalty
Note: Although the prepayment penalty is small, don’t forget that SBA 504 loans are assumable. Don’t overlook the benefit of having a new borrower assume a 504 loan with 16 or 17 years remaining at a low fixed rate of 4.960%. The 10-year effective rate remains an even lower 4.510%. What could be more appealing to a new buyer down the road than the opportunity to assume a fixed interest rate loan in these ranges?
SBA 504 Loan Interest Rates & Fees: Bank or Nonbank Lender Portion of the Loan
The interest rate offered on the lender portion of an SBA 504 loan is at the discretion of the bank or nonbank lender and typically ranges from 5% to 10%. Ultimately, you and your representatives must negotiate the best possible rates, fees, and terms for your deal. Beyond being a qualified borrower, you will also benefit from having a robust business plan, complete with detailed financial projections.
Summary of Lender SBA 504 Loan Interest Rates & Fees
|Term and Amortization|
In most cases, the bank/nonbank lender loan will have a five- to 10-year term amortized over 20 to 25 years. In the case of loans with 10-year terms, the interest rates usually reset after five years. This means that after five years, your interest rate could go down, go up, or stay the same. It depends on what the market rates are at that time.
While the long amortization will keep your monthly payment lower, it will also mean you have a balloon payment due in five to 10 years. At that point, the remaining balance is due in full leaving you to pay the balance or, as is more often the case, refinance the loan and continue making monthly payments.
Refinancing a first mortgage when a balloon payment comes due can be problematic, in some cases. If your business (or industry) sees a downturn prior to refinancing or if your property has significantly depreciated, it may be difficult to find a lender willing to work with you.
The bank portion of the loan may come with its own set of closing costs and third-party costs, such as appraisal fees, environmental fees, and architectural and legal fees. Fortunately, these too can typically be included in the financing.
Another SBA-backed option that avoids the prospect of balloon payments is an SBA 7(a) loan for commercial real estate. If you have been in business for at least one year, and have a credit score above 550, you may be a good candidate for an SBA 7(a) loan through South End Capital. South End Capital offers loans from $30,000 to $23 million at rates as low as 6.5%. You can apply online in minutes.
How to Apply for an SBA 504 Loan
The bank portion of an SBA 504 loan can be funded by national banks, community banks, credit unions, and more. Regardless of the lender, you’ll need to find a CDC willing to work with you on the loan. The first step is to make initial contact with a bank or CDC to get the process started.
There are 243 CDCs nationwide. To find one that will work with you, we suggest using the SBA’s CDC Finder tool. To find a bank, you can try your local bank, or the CDC might recommend a number of banks that it has worked with in the past. SBA district offices also sometimes compile rankings of the top 504 lenders in the region.
We recommend working with Liberty SBF for SBA 504 loans. If you have a credit score above 680, you’ve been in business for at least three years, are profitable, and need more than $1 million, Liberty SBF can help you get the SBA 504 loan you need.
Why Your Banker Might Not Offer SBA 504 Loans
The reason banks can seem conflicted when it comes to SBA 504 loans is that the economy and real estate market continue to improve. As the market rebounds, banks have been making efforts to increase the number and size of the commercial real estate loans they issue. Loan officers have a financial incentive (bonuses) to loan as much money as possible to a borrower, providing the loan meets the bank’s underwriting standards.
Bankers have complicated relationships with CDCs when it comes to SBA 504 loans. On the one hand, loan officers at banks are the top source of small business referrals to CDCs. At the same time, loan officers can feel pressure not to make referrals to CDCs.
When loan officers partner with a CDC to provide a small business an SBA 504 loan, they limit the bank’s loan size to 50% of the project, but it might have been as much as 80% had they funded alone.
There are other reasons why many loan officers don’t promote the SBA 504 loan program. These include:
- Processing time is slower: The process moves slower when there is more than one lender involved.
- Lack of knowledge about the program: Many loan officers are more familiar with the SBA’s 7(a) loan program, and don’t know enough about the SBA 504 program to recommend it.
- Compensation to the bank is slower: Banks can see a quicker payout by selling the guaranteed portion of a 7(a) loan than collecting interest and fees on SBA 504 loan.
This doesn’t mean that there isn’t a need for these loans, however. As the numbers of SBA 504 loans issued grows year-over-year, so does the diversity of the loan recipients.
Who Is Getting Approved for SBA 504 Loans
The SBA issued more SBA 504 loans in 2018 than in the last four years. According to 2018 SBA loan data, nearly 90% of SBA 504 loans go to established businesses. While startups aren’t receiving a lot of SBA funding, the Small Business Administration makes a significant impact on women and minority-owned businesses with nearly 33% of the SBA 504 loan funds going to each of these groups.
Throughout the past six years, existing businesses were the predominant borrower for SBA 504 loans. However, in 2018, 72% of all SBA 504 loans were given to new businesses. This may be due in part to the SBA’s new strategic plan that has put greater emphasis on funding new businesses.
Women-owned businesses are getting approved for SBA 504 loans in 2018 at a higher rate than they have at any point in the last five years. Women-owned businesses have received 28% of all 504 loans in 2018 and received 31% of the money disbursed.
SBA loans are a great option for minority-owned businesses. They have policy goals that encourage them to lend to minorities. Even better, minority-owned businesses received 30% of all SBA 504 loans in 2018 as well as 30% of the loan funds expended. SBA 504 loans to minority businesses have continued to increase annually.
Despite the complex nature of combining two separate loans through an SBA 504 loan, the program continues to grow annually. However, because of its complexity, there are many misconceptions about the SBA 504 program.
Misconceptions of CDC/SBA 504 Loans
The average small business owner doesn’t think about SBA 504 loans until they’re ready to buy commercial real estate. Due to the unfamiliarity of SBA 504 loans, there can be misconceptions about the program for borrowers. The most common misconceptions are in regard to the amount of paperwork, the associated prepayment penalties, and the assumability of the loans.
To help us clear up the top three misconceptions around SBA 504 loans, we spoke with Kristin Wood, an SBA loan specialist since 1989, and the Executive Director of SPEDCO, a CDC which serves the states of Minnesota and Michigan.
Here’s the top three misconceptions:
- There is a ton of additional paperwork for 504 loans: “Simply, not true,” says Wood. With the exception of a couple of documents, the paperwork is the same for an SBA 504 loan as it is for a conventional commercial mortgage.
- There are large prepayment penalties: “The penalty currently starts at under 3% and decreases by 10%-20% per year,” says Wood. After 10 years, there is no prepayment penalty.
- The loans are not assumable: If one refinances the bank loan, the CDC loan needs to be paid off. “The loans are assumable,” says Wood. If a small business refinances the bank loan, the loan from the new lender will be senior to the CDCs loan, just like the original bank loan.”
SBA 504 Loan Frequently Asked Questions (FAQs)
We have covered a lot of information regarding SBA 504 loans, what they are, how the bank and CDC loans work, and how to qualify for them. If you have any questions about any of the information presented here, you can post them in the Fit Small Business forum.
How much down payment do I need for an SBA loan?
In general, you will need a down payment of at least 10% to 20% for an SBA loan. In addition, you will also need to be eligible for the type of SBA loan you’re applying for. Requirements include having a credit score of at least 680, a debt service coverage ratio of at least 1.25x, and demonstrated repayment ability.
Can an SBA loan be used to purchase real estate?
SBA 504 loans, with a maximum loan amount of about $14 million, can be used to purchase commercial real estate that’s at least 51% owner-occupied. Additionally, loans through the SBA 7(a) loan program, with a maximum loan amount of $5 million, can be used to purchase real estate.
How do I qualify for an SBA 504 loan?
To qualify for an SBA 504 loan, you will need to have a credit score of at least 680, and a debt service coverage ratio of at least 1.25x. A minimum down payment equal to at least 10% of the loan will be required. Additionally, you will need to have a clean financial history.
Bottom Line―SBA 504 Loan
An SBA 504 loan is one of the first types of financing you should consider if you’re purchasing commercial real estate to operate your business out of, or if you’re buying long-term equipment that holds its value. The low interest rates and long repayment terms will be easier on your cash flow, and the low down payment will allow your small business to preserve more cash for working capital.