Understanding the SBA 504 prepayment penalty

The prepayment penalty for SBA 504 loans is sometimes misunderstood by potential borrowers and industry professionals, alike.

There are two ways to avoid the prepayment penalty entirely:

  1. Wait to pay off the loan: there is no prepayment penalty after 10 years on 20-year term loans.
  2. If you are selling the building, consider having the purchaser assume the loan, in which case the prepayment penalty does not apply.

If you choose to pay off a 20-year SBA 504 loan in the first 10 years, there is a pre-determined, non-negotiable prepayment penalty required by the SBA. Here’s what you need to know:

  • The prepayment penalty declines in an accelerated fashion over the first 10 years and is eliminated in year 11.
  • The prepayment penalty is calculated based on the loan debenture rate. For example, in February 2016, the debenture rate was 2.27% (the debenture rate is significantly lower than the effective rate).
  • The maximum prepayment penalty would be the full debenture rate (2.27% in this example) of the principal remaining on the second mortgage. This amount declines by 10% each year, so five years in, the prepayment penalty would be cut in half, or approximately 1.14% of the outstanding balance.

If you have a 10-year-term loan, the same principles apply; the penalty declines in an accelerated fashion over five years.

By strategically planning your payoff, you can save. If you are planning to pay off your loan early, TMC can help you make the best decision.