The Small Business Administration’s (SBA) 504 loan is designed for business owners looking to expand their businesses. One of the greatest benefits of this loan is its low barriers to obtaining credit. Let’s take a closer look at how to get this loan, in particular the SBA 504 loan collateral requirements that might have small business owners stumped.
What Is 504 Loan Collateral?
Collateral is the property purchased with a real estate loan. A lender will ask for collateral in order to secure the loan, which means it assures the lender(s) that you have a source of funding to repay the loan. If you stop making payments on the loan, the lender(s) can take possession of the property through the process of foreclosure.
A loan is only considered secure as long as the property is worth more than the amount remaining on the loan. A 504 loan requires no collateral other than the property acquired, but conventional lenders—banks or finance companies—may ask for property in addition to what you are purchasing with the loan in order to secure it, such as your personal residence.
Is Collateral the Same Thing as a Personal Guarantee?
Both conventional lenders and the SBA require personal guarantees from the business owner(s). This is a legal agreement that enables the lender(s) to claim the personal assets of the owner(s) if necessary. This might come up if the property were foreclosed and sold, and the sale didn’t cover the debt—which is known as a short sale.
Personal guarantees reduce the lender’s risk from the loan by sharing it with the borrower. Owners of the business with shares of 20% or more (and their spouses if they jointly own a share of that size) will sign personal guarantees.
How a 504 Loan Works
The 504 loan is intended to finance the purchase of land, buildings and equipment with a service life of ten years or more. It can also be used for construction and for the renovation or upgrading of buildings.
The 504 loan is a partnership between a conventional bank lender, a Certified Development Company (CDC) and the borrower. A CDC is a regional nonprofit organization set up specifically to administer the 504 loan program.
A 504 loan is structured into three parts, like this:
- The first part is a loan from a conventional lender for 50% of the total amount. You and that lender determine the amount and conditions of that loan, which becomes your first mortgage.
- Your CDC facilitates a separate SBA loan of up to 40% of the total, with a maximum of $5 million. You can receive up to $5.5 million for manufacturing projects or projects eligible for the SBA’s Green Energy Program. This will be your second mortgage.
- The borrower contributes at least 10% of the total project amount as a down payment. Certain types of facilities are classified as single-purpose properties by the SBA and require a 15% down payment.