SBA 504 Loans vs Conventional Loans: What Small Business Owners Need To Know

Looking for a loan to finance a commercial real estate purchase is a milestone in the life of your business. It also marks the beginning of a flurry of terms, conditions, calculations, and decisions. One thing to keep in mind as you embark on this journey is the difference between a conventional loan and the 504 loan offered by the Small Business Administration. This will help you determine what kind of loan is right for you as you evaluate your financing options.

Considerations for Every Loan Borrower

Financial institutions are competing for your business. This is a good thing, but it doesn’t necessarily make the process of finding a loan simpler, and gives you access to a profusion of offers that may vary in key ways (or may only appear to). As a borrower, you should have a thorough understanding of your needs in order to identify the loan that is right for you. Among the variables that loan borrowers face are:

  • The size of the down payment
  • The term of the loan and its amortization
  • The presence or absence of balloon payments
  • Whether the interest rate is fixed or variable

But the principle is always the same: lender and borrower engage in a process of give and take to make sure both their interests are best met.

Conventional Loan Scenario SBA 504 Loan Scenario
Sample amount $1 million $1 million
Down payment 25-40% 10%
Interest 5% (7-year) 4.66% (20-year) – 4.49% (10-year)
Balloon payment $610,008.95 None

Advantages of the 504 Loan: Down Payments, Interest Rates, and Amortization

Conventional loans can vary widely depending on the lender. The general outlines are likely to include a down payment of anywhere from 25-40%. The SBA 504 requires a down payment of 10% (or 15% for hospitality projects), offering a potential reduction in upfront costs of tens of thousands of dollars.

The borrower will usually consider whether to choose an offer with a variable interest rate or a fixed rate. This is a complex question, so a helpful rule of thumb is that fixed rates are preferable when interest rates are rising, and variable rates are better when rates are falling, so the rates on the loan decrease as well.

A major issue borrowers face with conventional loans is the presence of balloon payments. A loan will have a balloon payment when the amortization exceeds the term of the loan. For example, a $1 million loan with a 20% down payment at 5% interest, a seven-year term, and a twenty-year amortization period has monthly payments of $5,279.65 for seven years. Then, suddenly, a final balloon payment of $610,008.95 is due—thirteen years of payments rolled into one. If you can’t pay it immediately, it gets refinanced and new interest costs are added. Depending on the prevailing interest rates at the time, your rate could jump 5-7% when refinancing a conventional loan.

You should carefully consider the terms of your loan and their implications before any agreements are made. The 504 loan has fixed rates tied to U.S. Treasury issues that are below the market rate. That low rate is locked in for up to twenty years; in May 2017, rates were 4.66% on twenty-year loans and 4.49% on ten-year loans. All 504 loans are fully amortized, which eliminates the burden of a balloon payment.

Why the SBA 504 Loan Is Different

The 504 lending process represents a different approach to lending, and benefits from a partnership with a Certified Development Company (CDC), a nonprofit corporation certified and regulated by the SBA that works to provide financing to small businesses . With a down payment of 10%, the CDC will provide funding of up to 40% of a project to a maximum amount of $5 million ($5.5 million for a green project), working with a bank to cover the rest of the financing.

  • 50% Bank
  • 40% CDC
  • 10% Borrower

*The bank offers 50% of funding and a CDC will cover 40%, which only leaves the borrower to cover 10%

The biggest myth about SBA loans is that only very small businesses or small projects qualify. In fact, the majority of privately owned, for-profit businesses in the U.S. qualify for 504 loans. There is a cap on the size of the SBA second mortgage provided through your CDC, but it is combined with a first mortgage from a bank. As long as you stay within the CDC lending limits, you can take out as many SBA loans as you need.

Another common misperception is that the 504 loan process is slow and complicated. It’s not. CDCs can prequalify a borrower in 48 hours with minimal documentation. The approval process is streamlined and efficient, making it seamless for the borrower.

The Crucial Difference: Certified Development Companies

The involvement of Certified Development Companies is one of the most substantial differences between a 504 and conventional loan. There are 270 CDCs throughout the country, each with a specific geographical concentration. CDCs strive for fast results and make borrowing easier by guiding the borrower through the SBA qualifying process.

If you go to a bank, you may be referred to a bank-affiliated CDC, but it’s important to note that there will usually be more than one CDC available to you, and choosing the CDC with the most experience and advocacy will make all the difference. It is best to look for a CDC in your area with a lengthy track record, readily available support, and experienced advisers who can guide you to the best possible financial outcome. With the help of the right CDC, a 504 loan can be obtained quickly through clear, manageable steps.

While every borrower must make the loan choice that is right for them and their real estate goals, many businesses do choose to take advantage of the 504 loan over conventional options. This not only enables them to qualify with lower down payments and avoid balloon payments, but also sets them up to work with CDC professionals to make sure the process goes as quickly and smoothly as possible. If you think you might need an experienced guide to the 504 loan application process and want to make sure you’re taking advantage of all the options available to you, consider getting in touch with a CDC like TMC Financing.

With over 35 years of experience, TMC Financing is one of the nation’s top-ranking CDCs and a Premier Certified Lender with SBA. If your business is located in California or Nevada and you are thinking about the possibility of owning your own property, or even if this idea is brand new to you, get in touch with one of our local 504 loan experts to learn about your options. We can help by offering consultations or by prequalifying you to give you better leverage when working on acquiring a building. TMC loan experts are happy to provide guidance through the whole process and will do what is best for you – even if that means taking a different direction from a 504 loan.

No matter where you are in the process—whether you just learned about 504 financing or if you are already shopping for a building—your best bet is to contact a 504 expert at TMC for more information.

Barbara Morrison

Barbara Morrison

Barbara Morrison, a local small business advocate and civic leader, founded her first company TMC Financing in 1981. TMC is a Certified Development Company that provides commercial real estate financing to small business owners via the SBA 504 Loan Program. TMC consistently ranks among the top certified development companies nationwide, and has funded projects worth more than $9 billion across California and Nevada. Nearly 5,000 small businesses have benefitted from this financing, resulting in the creation of an estimated 50,000 jobs. TMC is also the No.1 SBA 504 hotel lender in the United States. Barbara is also the founder of Working Solutions, a Bay Area microlender whose mission is to provide micro entrepreneurs, particularly low-income individuals, women and minorities, with the access to capital and resources they need to start a successful business.
Barbara Morrison