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What You Need to Know About SBA Loans

Take into consideration all the different types of SBA loans and how they work before you apply for one to help get your small business started.

Starting a business is a rewarding, and expensive, experience.

If you don't plan for every little expense that your business needs to grow, it'll end up costing you more than you anticipated.

That's where an SBA loan can come in.

What Is an SBA Loan?

An SBA loan is a loan guaranteed by the Small Business Administration, or SBA.

This federal program works with banks to help small business owners receive the loan money they need to grow their businesses.

Since many small business owners do not have the capital required to take their business to the next level, an SBA loan can help them solve the cash-flow problem and achieve their goals.

Partnered with lenders

It’s important to note that the SBA is not loaning money to small business owners.

The SBA partners with banks and financial organizations that do the actual lending.

Once a small business owner is approved for an SBA loan, the SBA guarantees the loan, which means it promises to pay the bank part of the loan amount if the small business owner is unable to pay the loan back.

Banks are more likely to make loans to small business owners if the SBA agrees to share the financial risk!

SBA Loans Are Different Than Bank Business Loans

Not all commercial bank loans are SBA loans. Only loans guaranteed by the SBA count as SBA loans.

If you get a bank business loan that isn’t guaranteed by the SBA, the bank takes on the full financial risk of the loan.

This is why bank business loans are often harder to get than SBA loans, especially if your business is relatively new.

SBA loans are also different from bank business loans because they have to follow both the SBA and the bank’s lending guidelines. Bank business loans only have to follow the bank’s lending guidelines.

Types of SBA Loans

There are many types of SBA loans available to small business owners.

Here’s a quick overview:

7(a) loans

These loans provide funding for a variety of business expenses such as equipment, inventory, or operating capital.

The 7(a) loan is the most popular SBA loan, and the SBA has developed special 7(a) loan programs for certain types of businesses, such as businesses in rural areas or businesses run by members of the military community.

504 loans

These offer long-term, fixed-rate financing for small business owners looking to purchase fixed assets such as buildings or land.

Disaster assistance loans

These are limited only to helping small businesses recover from natural disasters.

Microloans

These provide small businesses with loans of up to $50,000.

Instead of partnering with banks, the SBA partners with non-profit and community-based lenders to facilitate these loans.

SBA Express loans

These loans are designed for small businesses that need money quickly. It takes weeks to go through the process of applying for a 7(a) loan, but SBA Express loans get processed much more quickly.

The initial decision from the SBA arrives in under 36 hours, although you still need to be approved by a lender to receive your funds. SBA Express loans generally come with higher interest rates.

CAPLines

These are not installment loans. Rather, they provide small businesses with fixed or revolving lines of credit -- an alternative to business credit cards.

How to Know If Your Business Is Eligible

Not all small businesses are eligible for SBA loans. The SBA sets size standards for what defines a “small” business. These standards vary by industry, but if your business is too large, it won’t be eligible for an SBA loan.

Your business must be based in the United States or its territories, and it must have a sound business purpose.

The SBA will not loan money to businesses engaged in illegal activities, nor will it loan money to pyramid schemes or businesses primarily dealing in speculation.

Real estate investment firms, gambling businesses, banks, leasing companies, insurance companies, coin and stamp dealers, charities, and religious businesses are also ineligible.

Businesses with bad credit are eligible for SBA loans, but businesses must be able to repay the loan.

Owners must have reasonable equity available to invest in the business and must have tried alternative methods of financing, including personal assets, before applying for an SBA loan.

Individual lenders also have their own rules about which types of businesses are eligible for SBA loans.

Bank of America, for example, requires businesses to be for-profit, legally organized (sole proprietorship, LLC, C-corp, etc.), and unable to qualify for conventional credit.

Picking the Right Bank

It is possible to start your SBA loan application process through the SBA website.

The SBA provides a Lender Match service that can connect you with banks and lenders interested in helping you get your loan.

However, it’s also possible to start the SBA loan application process through a bank.

If your business already has a bank account or a line of credit with a specific bank, for example, it might make sense to talk to a bank representative about SBA loan options.

Before you reach out to a bank about SBA loans, check the bank’s terms and conditions.

Remember that each bank sets its own lending criteria, and some banks might be more likely to grant your small business an SBA loan!

It’s worth it to compare a few different banks before making a decision.

The Application Process

The SBA loan application process is lengthy and should not be taken lightly.

In addition to filling out various application forms, small business owners also need to provide additional documentation, such as:

  • Articles of organization
  • Business licenses
  • Income statements
  • Balance sheets
  • Business debt schedules
  • Cash flow projection for the next year
  • Tax returns for the past three years
  • Personal financial statements

Certain types of loans require even more documentation.

If a small business owner wants to use their SBA loan to purchase real estate, for example, they’ll need to provide real estate purchase agreements.

The SBA wants to make sure that you are prepared to use the money for its stated purpose, and that you have the financial capacity to pay the money back.

The Terms of an SBA Loan

SBA loans are designed to have relatively low interest rates and long repayment terms.

If you take out an SBA 7(a) loan, for example, you’ll get up to 7 years to pay off a working capital loan, up to 10 years to pay off an equipment loan, and up to 25 years to pay off a real estate loan.

The interest you pay on your SBA loan depends on a number of factors: the amount of money you plan to borrow, the amount of time it’ll take to pay it back, and your (and your business’s) credit history.

However, the interest cannot go higher than the SBA’s maximum interest rate, which is based on the prime rate plus an allowable spread.

Be aware that interest rates can be fixed or variable. If you have a variable interest rate loan, this means that your interest rate can change over time.

It’ll still be based on the prime rate plus a spread, but it might go up or down along with the prime rate.

Fees

In many cases, you’ll also pay the SBA’s guarantee fee. Remember: the SBA guarantees that it’ll pay the lender a percentage of your loan if you default.

The lender is responsible for paying the SBA a guarantee fee, but they often pass those costs along to you.

Luckily, the SBA limits how much you can be charged in guarantee fees — and if you have a 7(a) loan of less than $150,000, you won’t be responsible for paying any guarantee fee costs.

If you do end up paying a guarantee fee — as well as any other fees associated with the loan, such as closing fees — you won’t have to pay those fees all at once.

They’ll be combined with your interest rate and calculated into your APR.

If You Do Not Get Approved for an SBA Loan

Here are some of the most common reasons why SBA loan applications are denied:

  • The business is not making a profit
  • The loan request is too large
  • The small business owner has not put enough equity into the business
  • The financial projections suggest that the business will be unlikely to pay back the loan

The SBA and its lending partners are looking for small businesses that have a history of turning a profit and a likelihood of being able to pay back their loans.

They’re also looking for small business owners with skin in the game — and yes, this means supporting the small business with equity and personal funds.

If you don’t get approved for an SBA Loan, don’t give up.

There are many other ways of funding your small business, from applying for a standard business loan to starting a crowdfunding project.

You could even take out a personal loan.

You could also work on strengthening your business — maybe you need to focus on profits, for example — so that you’ll be more likely to get accepted for an SBA loan the next time you apply.

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