What Is an SBA Loan?

What Is an SBA Loan?

A Small Business Administration loan is a small business loan guaranteed by the U.S. Small Business Administration (SBA). These loans can be used by businesses to cover startup costs, expansions, real estate purchases, and a wide range of other expenses. They are not issued directly by the government but by banks and other financial institutions.

How SBA Loans Work

SBA loans are used by thousands of businesses each year to borrow capital. Though they are called SBA loans after the U.S. Small Business Administration, this agency doesn't actually do the lending. Instead, the SBA works with a network of approved financial institutions that lend money to small businesses, and the SBA partially guarantees the loans.

The loan guarantee means that if the borrower is unable to pay back the loan to the lender, the SBA will step in and pay. This significantly reduces lenders' risks, which makes them more willing to lend to small businesses.

To reduce its own risk, the SBA requires an unconditional personal guarantee from everyone with at least 20% ownership in the company. This means that they are personally responsible for repaying the SBA if the business fails to make the payments.

Interest Rates on SBA Loans

There are several types of SBA loans. The most common, the standard 7(a) loan, allows businesses to borrow up to $5 million. The interest rate you'll pay is the prime rate plus a spread. The prime rate is a benchmark rate based on the Federal Funds Target Rate range (usually by adding a specific percentage to the top number of the range), and it changes when the Federal Reserve changes the rate range.

The size of the loan spread—that is, how much more the lender can charge you above the benchmark rate—is subject to maximums set by the SBA. It's determined by the size of your loan, your loan term, and your loan type (whether it is a fixed-rate loan or a variable-rate loan).

For example, in late September 2024, the most a lender could charge for a variable-rate SBA loan of $50,000 or less was the base rate plus 6.5%, while the maximum on loans of $350,000 or more was the base rate plus 3.0%.

On fixed-rate loans, interest rates can range from the prime rate plus 5% to 8%, depending on the size of the loan.

Eligibility Requirements for SBA Loans

The rules for getting an SBA loan are relatively strict. Among other requirements, you must prove that your business is a small business as defined by the SBA and that you have sought and failed to obtain other forms of financing before applying for an SBA loan.

Additionally, your personal credit score must meet that lender's criteria, and you should have solid annual revenue from your business.

The SBA requires collateral for certain types of loans over $50,000. However, lenders may require additional collateral for some loan types. Here are the primary SBA loan types (the 7(a) loan program is the primary small business program) and their collateral requirements:

• Standard 7(a): Lenders must obtain a security interest in all assets the loan proceeds are used for.
• 7(a) Small: No collateral for loans up to $50,000 except for International Trade loans; for loans of $50,001 to $500,000, lenders have to follow their established policies for similar non-SBA guaranteed loans.
• SBA Express: No collateral for loans up to $50,000, and lenders can use their own policies for loans over $50,000.
• Export Express: No collateral for loans up to $50,000, and lenders can use their own policies for loans over $50,000.
• Export Working Capital: Foreign accounts receivable and export-related inventory are generally considered adequate collateral.
• International Trade: Collateral is a lien on the business assets acquired by the loan or other business assets.

SBA Loans vs. Traditional Business Loans

Commonly-Used Types of SBA Loans

There are several different types of SBA loans, though some are only used in very specific circumstances. The most common types are:

SBA 7(a) Loans

• Loan limit: $5 million
• Interest rate range: Capped at the prime rate plus 3.0% to 6.5% for variable-rate loans and the prime rate plus 5% to 8% for fixed-rate loans
• Purpose: General business expenses or to fund purchases and expansion
  

SBA Express Loans

• Loan limit: $500,000
• Interest rate range: Capped at the prime rate plus 3.0% to 6.5% for variable-rate loans and the prime rate plus 5% to 8% for fixed-rate loans
• Purpose: Faster funding for working capital, expansion, and real estate and equipment purchases
  

SBA 504 Loans

• Loan limit: $5.5 million
• Interest rate: Pegged to an increment above the current market rate for 10-year U.S. Treasury issues
• Purpose: Purchase of long-term, fixed assets like land, machinery, and facilities
  

Pros and Cons of SBA Loans

As with any financial product, SBA loans have both advantages and disadvantages.

Pros Explained

• Competitive rates: SBA loan interest rates are calculated using the prime rate, on top of which the lender can add an extra percentage known as the spread. The SBA imposes a maximum limit on what lenders can charge for SBA loans, depending on the type and size of the loan.
• Low fees: SBA loans for $500,000 or less have no upfront or annual fees. Loans over that amount do have fees.
• Long terms: If you use your SBA loan for working capital, inventory, or equipment (with a life of less than 10 years), you'll have 10 years to pay it back. Use it for real estate, and you'll have up to 25 years.
• Large loan amounts: Commercial lenders normally cap their maximum loan amounts at $500,000 or $1 million. SBA loans can be much larger—up to $5 million for a 7(a) loan.
  

Cons Explained

• Strict eligibility requirements: To qualify, your business needs to meet a list of SBA requirements in terms of its size, type of business, and other factors.
• Slow to fund: The SBA loan application process requires quite a lot of documentation, and it can take one to three months for the funds to be released if you're approved.
• Personal guarantee required: The personal guarantee means that if your business can't make the loan payments, you'll be personally liable to repay the SBA.

How to Apply for an SBA Loan

1. Check your eligibility: Make sure your business is eligible by checking the SBA requirements on its website.
2. Choose a lender: The SBA offers a Lender Match tool to match potential borrowers with lenders within two days. You should look for a lender with extensive SBA experience.
3. Gather your documentation: SBA loan applications can require a great deal of paperwork, but your lender will be able to help you gather the necessary documents.
4. Submit your application: You'll send your application to your lender, who will forward it to the SBA for approval.
5. Wait: For a 7(a) loan, you might have to wait three months for the loan to be approved and funded. An SBA Express loan has lower limits, and you will pay an interest rate premium, but it is faster to fund, requiring no SBA approval.
   

The Bottom Line

If your business meets the requirements for an SBA loan, and if you can provide collateral and a personal guarantee, then this type of loan can be an excellent alternative to a traditional business loan—especially if you have tried and failed to obtain one. SBA loans have competitive interest rates and fees and fairly long repayment schedules.