What Is the Difference Between the 504 Loan and the 7(a) Loan?

As a small business owner hoping to invest in a facility, you might have come across the Small Business Administration’s (SBA) 504 and 7(a) loans in your quest for financing options. How do you know which one to choose? How do these two loans differ and what similarities do they have? It’s important to have a clear understanding of both options before beginning the application process.

What You Can Do With 504 and 7(a) Loans

Let’s start by looking at the purpose of these loans. They are both dedicated to supporting small businesses and helping them grow, but one might be more useful to you than the other based on your unique needs.

The 504 Loan

The 504 loan is intended for purchases that have permanent or long-lasting value. With a 504 loan, you can:

  • Purchase land or existing buildings
  • Construct new facilities
  • Renovate or convert existing facilities
  • Improve property with utilities, parking lots, landscaping, etc.
  • Buy machinery or equipment with a long service life (10+ years)

The 7(a) Loan

With a 7(a) loan, it’s possible to:

  • Pay operational expenses or accounts payable
  • Purchase necessary inventory, machinery or equipment
  • Obtain seasonal financing or contract performance
  • Purchase land or existing buildings
  • Construct new facilities
  • Renovate or convert existing facilities
  • Improve property with utilities, parking lots, landscaping, etc.
  • Finance exports
  • Establish a new business or assist in the acquisition, operation or expansion of an existing business

You will notice there are a few points of overlap between the programs. Both the 504 and the 7(a) can be used to purchase equipment or real estate, construct a new building, or renovate an existing facility. Both loans can be used for refinancing as well.

How You Get 504 and 7(a) Loans

Once you decide which loan is right for you and your growing business, it’s time to look into the conditions of the loan. Where does the financing come from? How much do you put as a down payment for each?

The SBA 7(a) loan program underwrites loans up to $5 million made entirely by conventional financial institutions. The SBA can guarantee as much as 85% on loans of up to $150,000 and 75% on loans of more than $150,000. SBA’s maximum exposure amount is $3,750,000. Thus, if a business receives an SBA-guaranteed loan for $5 million, the maximum guarantee to the lender will be $3,750,000 or 75%. The terms and conditions of the loan are determined in conjunction with the lender.

Often, personal property is used as collateral, which can be off putting for many borrowers as they are not keen on mingling their personal and business assets.

A 504 loan, on the other hand, has three parts:

  • There is a loan from a conventional lender, guaranteed by the SBA, with terms, including the amount of the loan, agreed on by you and that lender. This loan often covers 50% of the total loan. The conventional lender is the first lien.
  • You receive a second loan from the SBA, facilitated by a Certified Development Company (CDC). A CDC is a nonprofit organization set up specifically to take part in the 504 loan program. It ensures fully amortized loans at below-market rates. Their loan can account for up to 40% of the loan total, up to $5 million, or $5.5 for manufacturing and green projects.
  • Finally, you provide a 10% down payment.
  • 50% - Bank
  • 40% - CDC
  • 10% - Borrower

The two loan programs can be compared in the table below:

SBA 7(a) loan SBA 504 loan
Use Purchase, improvement, or construction of real estate, purchase of equipment/furnishings, working capital, inventory Purchase, improvement, or construction of real estate, purchase of equipment/furnishings
Amount of loan $5 million maximum The SBA second loan (40% of project) cannot exceed $5 million or $5.5 million for projects with energy efficiencies implemented.  There is no limit to the first loan or total project size.
Collateral Assets acquired + personal property Assets acquired
Terms 10-25 years 10 or 20 years
Rates Predominantly variable, tied to Prime Fixed, below-market rates
Down payment Negotiable,  10%-15% minimum 10% minimum (15% for hospitality ventures and startups)
Fees Paid out of pocket; usually 2.75% Included in the SBA loan; approximately 2.15%

The characteristics that often incline borrowers to lean towards the 504 loan include: the fixed variable rate, the fact that no additional collateral is required, and the favorable fees. The fees on a 7(a) loan get considerably larger with larger projects so from a fee perspective, the 504 loan is less expensive.

Besides providing a portion of your 504 loan, your CDC can help you find a conventional lender to work with and can be an invaluable source of information and guidance throughout the loan process.

TMC Financing is an SBA Premier Certified Lender and a high-volume loan provider. We have been helping business owners reach their goals for 35 years. Whether you are just beginning to explore your opportunities for financing or you have long experience with business loans, contact a TMC loan expert to find out more about the 504 loan.

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