Most SBA 7(a) mortgage loans are experiencing massive rate adjustments, and monthly payments are skyrocketing. Luckily, all hope is not lost. The SBA 504 loan program offers a critical refinancing lifeline for many owners. If you have an SBA 7(a) property loan, this article is for you.
Imagine your small business is a ship you’ve been sailing across the vast ocean of the marketplace. Your SBA 7(a) property loan was the tailwind that helped push you forward, making it possible to claim a piece of the business world as your own.
But now, you sense the financial climate has shifted, and the sailing isn’t as smooth. Rising interest rates have created unpredictable currents and choppy waters. You’re feeling the gusts of rising adjustable-rate SBA loans and seeing your monthly payments puffed up to new highs.
Don’t despair fellow captains. In this article, we're diving into SBA 7(a) loans and why this perfect storm of rates is upon us, and we’ll help you chart a course toward the safe harbor of a fixed-rate refinance to help you keep more of your treasure in your pocket.
Table of Contents
What is an SBA 7(a) Loan?
OK, first, some quick basics. What exactly is the SBA? The Small Business Administration (SBA) is a government agency that helps power the U.S. economy by championing the growth of small businesses. The SBA 7(a) loan program is their flagship offering.
The SBA doesn’t actually make loans. Instead, they provide guidelines for lenders and offer loan guarantees to approved lenders that make loans using the guidelines. These guarantees provide incentive to lenders to provide financial help to small businesses in the form of loans.
The SBA 7(a) loans can be used for a variety of purposes, including acquiring, refinancing, or improving real estate, providing working capital, refinancing business debt, purchasing fixtures or equipment, buying inventory or supplies and changing ownership.
These loans can be a real lifeline for small business owners, often providing financing where banks may not otherwise help out. The SBA 7(a) loans historically offer reasonable terms, often allowing entrepreneurs to purchase a business property with very little money down.
All good so far. The issue? A significant number of SBA 7(a) loans related to real estate are adjustable-rate loans. This means their interest rates, usually linked to the Prime rate, are susceptible to fluctuations. With the Prime rate rising so much lately, many owners are seeing their monthly payments soar.
The Recent Surge in Interest Rates
If you've been following financial news, you're likely aware of the Prime rate's dramatic ascent in the past year or so. From May 2022 to October 2023, the Prime rate rose from 3.5% to 8.5%. This is one one of the fastest 5% rises in history!
For many of you with small business loans, this means one particularly difficult thing: higher interest rates on your SBA 7(a) loans. Rates that were once comfortably in the 6% to 7% range have now skyrocketed to the 11% to 12% neighborhood. Not such a nice neighborhood!
We’ll get to some examples in a moment. But for almost any property loan size, the jump in the monthly loan payment on adjustable SBA 7(a) loans has been a huge and quite unexpected hit to business cash flow.
The Urgency of Refinancing
In purely financial terms, the need to refinance SBA 7(a) property loans could not be more urgent and apparent. Let’s use a simple example.
In purely financial terms, the need to refinance SBA 7(a) property loans could not be more urgent and apparent.
Imagine you bought your property with a $3 million SBA loan. A common rate in the last five years would have been 7%, with an approximate monthly payment of $21,200 on a loan that size.
In just the last 15 months, as the Prime has gone up by 5%, that property loan rate has gone from 7% to 11% or 12%. This means the current monthly payment is between $29,400 and $31,500. The monthly payment is now $8,000 to $10,000 higher than it was just a year ago. Incredible!
For an even more alarming perspective, how about the hit to cash flow on an annual basis? In 12 months, you will have to pay roughly $100,000 to $120,000 more in mortgage payments. This could easily mean the difference between making a profit and having a loss for the year.
The Benefits of Refinancing
If you’re an owner seeing your payments skyrocket, there is unfortunately no way to go back to the rate you had just 1 to 2 years ago. Higher rates are now a fact of life, and they aren’t likely to start dropping much anytime soon.
However, there is good news! There are mortgage alternatives to the SBA 7(a) loans that you can use to get a long-term fixed-rate loan with a much lower rate than your current adjustable SBA loan. One such loan is an SBA 504 loan, and we’ll share details about refinancing with 504 loans in a moment.
When it comes to the interest rate you can get when refinancing, as of November 2023 rates are between 7.5% and 8.5% (though they move constantly and depend on many factors - we’re providing a rough range here to give you an idea of what’s possible).
Let’s go back to the example above of the $3 million SBA 7(a) property loan. Let’s assume you have a current interest rate of 12%. If you refinance into an 8% fixed rate loan, the loan payments will go down by roughly $8,400 per month, saving you roughly $100,000 in cash flow in the next 12 months.
(Even more mind boggling: if that loan is held to maturity, the interest savings over the life of the loan could be as high as $2.5 million. That’s $2.5 million less paid in interest over 25 years!)
What Does it Take to Refinance an SBA 7(a) Loan?
Unfortunately, not everyone with an SBA 7(a) property loan will qualify to refinance into a new fixed-rate loan. Owners will face a number of requirements for most refinance loan programs. To get a lower-rate fixed-rate loan, lenders will be focused on some key factors, including:
Business profitability:
First and foremost, a lender need confidence they will be repaid. For a business to make their mortgage payments, the business need to have sufficient cash flow. Lenders will look at recent tax returns and year-to-date financial information to see business cash flow.
Personal credit score:
Even though they are for business, SBA loans and most business property loans require a review of credit scores of the owners. Most programs require scores of 660 or sometimes 680. All lenders set their own guidelines, so the score minimum actually varies from lender to lender.
Business credit score:
Just like with personal credit, there is no absolute standard on business credit scores for SBA or any other property loans. Lenders use their own standards, and they may look at scores provided by a number of companies, such as Experian or D&B.
Loan-to-value:
Loan-to-value, or LTV, refers to the amount of a loan compared to the value of the property. If you get a $900,000 loan on a property valued at $1,000,000, you have a 90% LTV loan ($900,000 / $1,000,000 = .90 = 90%). This is such an important topic, it gets its own section. Read on.
The Impact of Loan-to-Value (LTV) on Refinancing
Many SBA 7(a) loans made for real estate provide very high LTV’s - as much as 80-90% LTV. This means if you bought a property valued at $2 million, you might have borrowed $1.6 to $1.8 million. This was very helpful for reducing the cash needed to buy, but that high LTV can make refinancing harder.
If your property has lost value, the loan you need to refinance might now be an even higher % compared to the value of the property. For example, what if your $1 million property is now worth $900,000? If the loan outstanding is still $900,000, you now owe 100% of the value of the property (100% LTV). Lenders will not loan to 100% LTV, so you won’t find a refinance loan available.
Even if your property has held its value and not appreciated much, if you are in the first few years of your loan, you haven’t had time to pay down the principal very much. This means you may still need a high LTV loan to refinance your current loan.
If you are refinancing an SBA 7(a) loan that was originally an 80% or more LTV, you probably will need a refinance loan now that will allow for LTV of 75% to 90%.
Most traditional bank loans will not allow over 75% LTV, and some will not go above just 65-70%. This leaves very few options for refinancing real estate with higher LTV’s. Luckily, one great option does exist for business owners that have high LTV loans, and that’s the SBA 504 loan.
Luckily, one great option does exist for business owners that have high LTV loans, and that’s the SBA 504 loan.
SBA 504: The “Other” SBA Loan Program
You might have heard of SBA 7(a) loans and thought that was the only loan program made possible by the SBA. There is another loan program, far less widely known, with a much narrower range of allowable uses. This program is the SBA 504 program.
Whereas the SBA 7(a) program is for a wide range of business purposes, the main purpose of the SBA 504 loan program is to provide long-term, fixed-rate financing for major assets such as buildings and land.
SBA 504 loans are characterized by favorable terms, including:
Long repayment periods, up to 25 years
Fixed interest rates that are often below market rates and fixed for 5 to 25 years
For purchases, a low down payment requirement (usually around 10% to 20% of the project cost)
For refinances, a high LTV allowed (loans usually up to 85% or 90% of the value of the property)
SBA 504 Loans for Refinancing
The SBA 504 program started in 1980, and historically, small businesses used SBA 504 loans to acquire or improve properties for their operations. It wasn’t until 2016 that the SBA expanded the guidelines to allow 504 loans to be used to refinance eligible long-term debt.
However, for many years, SBA 504 loans could not be used to refinance SBA 7(a) loans. That restriction was finally removed during the pandemic, in 2021. This change was less Important in 2021 and 2022, as interest rates on SBA 7(a) loans were still at historic lows. There was little need to pursue refinances of SBA 7(a) loans.
But with rates skyrocketing in the past 12 months, many business owners are faced with the sudden newfound need to refinance. For these owners, the SBA 504 loan program could be the lifeline for refinancing higher interest rate loans into fixed-rate loans.
SBA 504 loans offer an array of benefits for owners with business property mortgages. SBA 504 loans offer the highest LTV loans in the marketplace. They also usually provide the longest fixed-rate terms found on business property loans.
An SBA 504 loan can be used for not only real estate refinancing but also for the purchase of machinery and equipment. They also may allow some loan proceeds to be used for certain operating expenses.
What’s the Harm in Just Waiting for Rates to Drop?
Some owners see their payments going up but hope that rates will come back down eventually. If you can save money today by refinancing, it is very likely in your best interest to not wait. What’s the possible harm in just waiting?
The most obvious harm in waiting is continuing to pay more in interest than you need to. We’ve discussed the huge savings on monthly payments and interest expense that can come from refinancing. But if the savings don’t seem compelling, there are other risks involved with waiting:
Inability to refinance later:
If your property value goes down, you may lose the ability to refinance at all. As your property value goes down, the LTV of any refinance loan you need will go up. If you need a refinance loan of over 90% LTV, you probably won’t qualify for any loans, including an SBA 504 loan.
Further rise in rates:
If you have an adjustable rate loan and the Prime rate continues to go up, your payments will only go higher. And the rates on any refinance options will climb higher as well. So, if you wait and interest rates do not magically drop, you could be facing much worse options in the future.
Business risks:
If you wait to refinance, not only is there interest rate risk and property value risk, but you also have business performance risk. To qualify for a loan, your business has to show it can repay the debt and isn’t struggling. If you can qualify now but decide to wait, a future slowdown in business could hamper your ability to refinance later.
How to Get Started with SBA 504 Refinancing
So, how do you get started with this money-saving mission? It begins with finding the right lender. There are hundreds of lenders that offer SBA 504 loans, and each puts its own guidelines on top of the SBA guidelines.
For example, some lenders won’t loan to restaurants, and others won’t loan to hotels. Some will loan to 90% LTV and some will go over 90% LTV. Some lenders require 680 credit scores, while others will consider much lower credit.
To ensure you find an appropriate lender, and get great terms, consult with professionals who specialize in SBA 504 loans and refinancing SBA 7(a) property loans. Companies like Everfund and other experienced financing brokers can guide you through the process and help connect you with the right loan for your situation.
Conclusion - Don’t Wait
The urgent message we’re sharing here is pretty straightforward: if you have an adjustable rate SBA 7(a) loan on your business property, refinance it now. Don’t wait thinking you can do this in the future or that rates will definitely come back down.
The most likely way you'll refinance your SBA 7(a) loan into a better long-term fixed rate loan is with a SBA 504 refinance loan. Thanks to guideline changes made during the pandemic, an SBA 504 loan can now be used to refinance your SBA 7(a) loan.
The SBA 504 loans offer high LTV's, fixed rates and even possibly some proceeds for operating expenses. The long-term nature of the SBA 504 loans can give you peace of mind for years to come.
And perhaps most importantly, the savings potential is massive. By refinancing into a fixed-rate mortgage, you could save thousands per month and possibly hundreds of thousands over the life of the loan. That's money you can reinvest in your business, use for expansion, provide needed working capital, or simply lean on for financial cushion in the future.