Is an SBA Loan Right for You? SBA Loan Pros and Cons.

Deciding whether an SBA loan is right for you means weighing the pros and cons of SBA loans versus other types of loans. I’ll explain some of these pros and cons to help you make a better decision.

Pros of SBA Loans

Here’s a summary of the pros of SBA Loans:

  • Built to Support Small Businesses
  • The Loans Can Be Used for Many Purposes
  • Easier Access to Credit
  • Potentially Lower Interest Rates
  • Favorable Loan Terms and Fees
  • Low Down Payments

Below is a little more about each pro.

Built to Support Small Businesses

Sometimes business loans seem built for large businesses. This can be true because larger loans are more profitable for many lenders. These lenders then tend to work more with larger borrowers. However, SBA loans and SBA lenders specialize in working with small businesses. They understand the needs of a small business. Some SBA loan programs have simplified application processes. Some programs also provide support and guidance beyond the loan itself.

The Loans Can Be Used for Many Purposes

The standard 7(a) loans can be used for a wide range of purposes. 7(a) loan funds can be used for everything from short-term working capital needs to long-term funding for real estate purchases. You can use the funds to establish a new business or expand operations. The Community Advantage program can fund changes of ownership. Disaster Assistance loans meet unique dire needs in time of need. Microloans fill a need that’s often not met by traditional lenders.

These types of loans can sometimes be hard to get a loan for without the reduced risk to the lender provided by the SBA loan.

Easier Access to Credit

Prime lenders like banks and credit unions are required to have a low tolerance for risk when making loans. Small loans and small businesses are less profitable than large companies and large loans. When banks have limited capital and funds to lend, they have incentives to focus on larger companies that are more profitable and may be less risky.

SBA loans provide incentives for these lenders to serve small businesses. The SBA guarantee of a 7(a) loan or the junior lien of the 504 loan reduces the risk to the lender. Lenders can sell the guaranteed portion of SBA loans at a gain, which also frees up funding and capital.  

Many times during periods of economic stress for small businesses, the SBA has added programs or made programs more favorable to small businesses.

Potentially Lower Interest Rates

Lenders charge higher fees for higher-risk borrowers. SBA loans reduce the risk to the borrower, which can reduce the interest rate required by the lender to make the loan. Some SBA loans also come with mandated rate caps. Some loan programs have very low interest rates. SBA loan interest rates and fees may be much lower than those charged by non-bank lenders.

Favorable Loan Terms and Fees

The maximum repricing term for many banks and credit unions is around seven years. They often require a balloon payment of all outstanding principal amounts at ten years. You can get fixed-rate loans with no balloon payment with a 25-year term with SBA loans. Some lenders offer long-term fixed-rate loans but charge a “yield maintenance” or “make whole” prepayment penalty that can be very expensive. SBA prepayment penalties can be much lower than normal prepayment rates.

Low Down Payments

Down payments can be as low as 10% for both the 7(a) and 504 programs. This is lower than the 20-25% down payment that’s common for standard commercial real estate loans.

Cons of SBA Loans

And now a summary of the cons of SBA Loans:

  • Eligibility and Restriction on the Use of Funds
  • Potentially Higher Fees
  • Longer Loan Approval Process
  • More Paperwork
  • Collateral and Guarantee Requirements

Eligibility and Restriction on the Use of Funds

While SBA loan funds can be used for many things, they can’t be used for everything. Some programs are limited to certain uses. Some programs have eligibility requirements that your business may not qualify for.

Potentially Higher Fees

7(a) borrowers pay a guarantee fee that would be required for regular loans. 504 loans come with a series of one-time and ongoing fees that may not be charged if the borrower weren’t borrowing through the program. While these fees may seem high, the all-in cost of an SBA loan may still be lower than a loan without SBA assistance. The borrower may not be able to get a loan at any cost without SBA assistance.

Longer Loan Approval Process

Getting SBA approval adds another layer of review and approval to the loan application process. This can be reduced by working with a lender who is part of the Preferred Lender Program (PLP). These lenders aren’t required to submit loans for full SBA review. Using an Express program also reduces turnaround time.

More Paperwork

Government programs mean government forms. Lenders have their own set of loan application documents, and SBA loans require additional documents. Some lenders do a better job than others in reducing the duplication of paperwork. SBA loans promote public policy goals, so some paperwork is required to monitor the effectiveness of the programs in meeting these goals.

Collateral and Guarantee Requirements

Owners are required to provide a personal guarantee for SBA loans. Small businesses may have to pledge more collateral or different types of collateral than what would be required with a normal loan. Once again, this may be the price to be able to get a loan or to get a loan with the benefits of an SBA guarantee.

Is an SBA Loan Right for You?

The SBA has provided valuable funding for decades to small businesses. This article has given you an outline of some of the pros and cons. If you want to dig deeper into SBA loans, check out my SBA Loans course. SBA lenders, SBA business partners, your CPA, or other business advisors can help you decide if an SBA loan is right for your business.

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