If you own a small business, you may have heard that an SBA loan might be a funding option for a business like yours. What is an SBA loan? SBA stands for Small Business Administration, a federal agency that provides assistance and guidance for small businesses.
At MHV, we know how important it is for small business owners to understand their options. Here’s a look at how SBA loans work and the requirements to qualify for one.
Understanding SBA Loans
So, what is an SBA loan exactly? It’s a type of financing lenders extend to small business owners with backing from the SBA. This protects lenders by reducing their risk while also providing benefits for the business owner, who is able to take advantage of certain perks, such as lower down payments and flexible overhead requirements. Whether you need $500 or $5.5 million, you may find it useful to apply for an SBA-backed loan at some point in time.
Note that the SBA will only make a direct loan to businesses and homeowners impacted by a declared disaster. For that reason, we’ll focus on how SBA-backed loans work. There are several types of SBA-backed loans, including:
7(a) Loans
The 7(a) loan is the primary loan backed by the SBA. These loans can either have fixed or adjustable rates. The maximum loan amount is $5 million. You can use a 7(a) loan in a variety of ways, including for acquiring, improving, or refinancing real estate property or buildings; refinancing current business debt; or purchasing furniture, fixtures, supplies, or machinery and equipment. You can also use it for short- and long-term working capital.
504 Loans
A 504 loan is a fixed-rate, long-term loan. You can secure financing for up to $5.5 million through a 504 loan, though it operates a little differently than a 7(a) loan. Generally, 504 loan financing is extended for the purpose of promoting business growth and job creation.
Unlike a 7(a) loan, a 504 loan cannot be used to consolidate or refinance debt. It also can’t be put toward working capital, inventory, or financing AI-related working capital, intellectual property, or consulting service soft costs. Speculation or investment in rental real estate is another no-go for this type of loan.
Instead, 504 loans can be used for the purchase of buildings or land, new facilities, and certain long-term machinery and equipment. It can also be used for the improvement of land, streets, utilities, parking lots, landscaping, and existing facilities.
Microloans
Microloans are for small businesses that need financing of $50,000 or less. While SBA microloans cannot be used to pay existing debt or buy real estate, they can be used to enhance, rebuild, or reopen your small business. Microloans may be used toward working capital, inventory, supplies, furniture and fixtures, and machinery and equipment as well.
Securing an SBA Loan
While SBA loans are typically more flexible than traditional business loans, there are certain eligibility requirements that must be met in order to qualify for one. Each type of SBA-backed loan has its own set of requirements.
Certain types of businesses are ineligible for SBA-backed loans. Your business may also need to meet certain size requirements. For instance, a 504 loan requires a tangible net worth of less than $15 million and an average net income of less than $5 million after federal income taxes for the two years before your application.
You should consult with your lender about specific eligibility requirements. However, general requirements include:
- Be a for-profit business: Your business should be officially registered and used for legal purposes.
- Operate in the US or its territories: The physical business and its operations should be located within the US or US territories.
- Be creditworthy: You should be able to demonstrate your ability to repay the loan. However, you may be able to qualify for startup funding even if you have bad credit.
- Exhausted other financing options: The loan you are seeking is not currently offered on reasonable terms from non-government lenders.
Applying for an SBA Loan
You can apply for an SBA loan directly through your lender of choice. Be sure to:
- Apply for the right type of loan: Since some loan programs come with restrictions on how the financing can be used, ask your lender about any funding restrictions or eligibility requirements to get matched with the right loan type.
- Gather the necessary paperwork: Once you are matched with a loan and understand the eligibility requirements, organize all the necessary paperwork you may be requested to provide. This may help to speed up the application process.
- Shop around: Compare interest rates and loan terms. Consult with a trusted professional, such as an attorney, accountant, or financial advisor to ensure you are making a sound business decision.
- Avoid predatory lenders: Protect yourself from predatory lending practices. If a lender charges more than 5% of the loan value or offers interest rates steeper than those offered by competitors, it could be a warning sign that you’re dealing with a predatory lender.
When you’re ready, speak with Mid-Hudson Valley Federal Credit Union and meet with one of our business lending experts. We’re committed to helping you keep your business running as smoothly as possible and helping it grow.
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