The 7(a) loan program is the SBA’s most common small business program. Its name comes from section 7(a) of the Small Business Act, which authorizes the program. In this article, I’ll walk through many key elements of the 7(a) program and how you can apply for one.
The Purpose of the 7(a) Program
The 7(a) program helps small businesses get financing when they cannot otherwise obtain credit at reasonable terms.
The program covers businesses that have the cash flow to repay the loan but may not have the collateral or history required by a bank’s lending policy.
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What Can the Loan Be Used For?
7(a) loans can be used for:
- Long- and short-term working capital
- Revolving funds based on the value of existing inventory and receivables
- The purchase of equipment, machinery, furniture, fixtures, supplies, or materials
- The purchase of real estate, including land and buildings
- The construction of a new building or renovation of an existing building
- Establishing a new business or assisting in the acquisition, operation, or expansion of an existing business
- Refinancing existing business debt, under certain conditions
Borrowers are prohibited from using 7(a) loan proceeds to:
- Refinance existing debt where the lender is in a position to sustain a loss, and the SBA would take over that loss through refinancing
- Effect a partial change of business ownership or a change that will not benefit the business
- Permit the reimbursement of funds owed to any owner, including any equity injection or injection of capital for the business’s continuance until the loan supported by the SBA is disbursed
- Repay delinquent state or federal withholding taxes or other funds that should be held in trust or escrow
- Pay for a nonsound business purpose.
How Big Are 7(a) Loans?
The maximum loan amount for a 7(a) loan is $5 million. In FY2021, the average approved 7(a) loan amount was $704,581, and about 10% of all 7(a) loans exceeded $2 million.
The SBA guarantees 85% of the loan amount for loans of $150,000 or less and 75% for loans greater than $150,000. The maximum amount of the loan guarantee is $3.75 million.
Who is eligible for a 7(a) loan?
The eligibility requirements are the same as what was discussed earlier in eligibility. The business must:
- Operate for profit
- Be considered a small business, as defined by the SBA size standards
- Be engaged in, or propose to do business in, the United States or its possessions
- Have reasonable invested equity
- Use alternative financial resources, including personal assets, before seeking financial assistance
- Be able to demonstrate a need for a loan
- Use the funds for a sound business purpose
- Not be delinquent on any existing debt obligations to the U.S. government
What are the Loan Terms?
Loan maturities are based on the ability to repay, the purpose of the loan proceeds, and the useful life of the assets financed. The maximum maturities for SBA loans are:
- 25 years for real estate
- 10 years for equipment
- 10 years of working capital or inventory loan
These are the maximum terms. The loan maturity will be the longer of the economic life of the asset the loan is funding or the above maximum limits.
When loan proceeds are used for a combination of purposes, the maximum maturity can be a blended maturity based on the use of proceeds or the maximum for the asset class comprising the largest percentage of the use of proceeds.
These loan terms are much longer than most banks, especially smaller banks and credit unions, tend to lend. A common loan structure for these lenders is:
- Repricing every 5 years
- Balloons (i.e., all outstanding principal due) in 10 years
- Amortization term of 25 years
SBA 7(a) loans have no balloon term. They can fully amortize over the loan term limits described above. In addition, the loan interest rate could be fixed over that term. This is why some borrowers would prefer an SBA loan to regular loans banks or credit unions.
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SBA 7(a) Program Interest Rates
Interest rates may be fixed or variable. The repricing frequency must not be more often than monthly, and it must be consistent (e.g., monthly, quarterly, semiannually, annually, or any other defined period).
The rates are negotiated between the borrower and the lender. They are subject to SBA maximums, which are pegged to the lowest of the:
- Prime rate
- Optional peg rate (a weighted average of rates the federal government pays for loans with maturities similar to the average SBA loan)
The rates above are the index rate or “Base Rate.” A “spread” is added to this rate to arrive at the full rate paid by the borrower.
That spread is negotiated between the borrower and the lender subject to the caps below:
For Variable Rate Loans:
|Loan amount||Max rate if maturity is less than 7 years||Max rate if maturity is more than 7 years|
|$25,000 or less||Base rate plus 4.25%||Base rate plus 4.75%|
|$25,000 to $50,000||Base rate plus 3.25%||Base rate plus 3.75%|
|$50,000 or more||Base rate plus 2.25%||Base rate plus 2.75%|
For Fixed Rate Loans:
|Loan amount||Prime rate in effect on the first business day of the month, plus|
|$25,000 or less||8.0%|
|$25,000 to $50,000||7.0%|
|$50,000 to $250,000||6.0%|
|$250,000 or more||5.0%|
You will pay some guarantee fees to the lender, most of which will be passed onto the SBA. This is how the SBA funds itself. For all loans with maturities of 12 months or less, the fee is .25% of the guaranteed portion of the loan. For loans with maturities that exceed 12 months, the fees are:
|Gross Loan Size||Fee|
|$150,000 or less||2% of the guaranteed portion|
|$150,001 to $700,000||3% of the guaranteed portion|
|$700,001+||3.50% of the guaranteed portion up to $1,000,000 PLUS 3.75% of the guaranteed portion over $1,000,000|
Notice that the rate of the fee is set by the full amount of your loan, but the fee is only charged on the guaranteed portion of the SBA loan. For most 7(a) loan programs, the SBA can guarantee up to 85 percent of loans of $150,000 or less, and up to 75 percent of loans above $150,000.
Processing fees, origination fees, application fees, points, brokerage fees, bonus points, and referral fees that could be charged to an SBA loan applicant are prohibited. Lenders can charge a late fee not to exceed 5% of the regular loan payment.
For loans with a maturity of 15 years or longer, prepayment penalties apply when:
- The borrower voluntarily prepays 25 percent or more of the outstanding balance of the loan.
- The prepayment is made within the first three years after the date of the first disbursement of the loan proceeds.
The prepayment fee is as follows:
- During the first year after disbursement, 5 percent of the amount of the prepayment.
- During the second year after disbursement, 3 percent of the amount of the prepayment.
- During the third year after disbursement, 1 percent of the amount of the prepayment.
These prepayment penalties can be much lower than the standard penalties of banks and credit unions for long-term loans.
What Collateral and Personal Guarantees are Required?
For 7(a) loans of $25,000 or less, the SBA does not require lenders to take collateral. You will be required to pledge the asset being purchased as collateral. Also, if you have enough fixed assets and real estate to fully secure the loan, you will be required to pledge collateral to the maximum extent possible up to the loan amount. If business assets do not fully secure the loan, the lender may place a lien against the principal’s personal real estate (residential and investment).
The SBA directs lenders not to decline a loan solely on the basis of inadequate collateral. One of the primary reasons lenders use the SBA-guaranteed program is for those applicants that demonstrate repayment ability but lack adequate collateral to repay the loan in full in the event of a default.
Individuals who own 20% or more of a small business getting an SBA loan must provide an unlimited personal guarantee.
Types of 7(a) Lenders
Borrowers don’t get 7(a) loans directly from the SBA. You get 7(a) loans from lenders like banks and credit unions. That lender will decide if you qualify for a loan with them. They also will determine many of the details for your loan, like rates, subject to the SBA guidelines discussed above.
There are two lender classifications used by the SBA for 7(a) loans. You can ask the lender you are working with which classification they below to.
General Program (GP) Lenders
Many lenders, especially small lenders, fall into this category. These lenders submit the loan documentation to the SBA for approval of an SBA loan guaranty. The SBA doesn’t contact the borrower; the SBA talks with the lender. The lender talks with the borrower.
Preferred Lender Program (PLP) Lenders
PLP lenders draft the SBA Authorization (of loan guaranty approval) without the SBA’s review and execute it on behalf of the SBA. The SBA only does a brief eligibility review of the loan. This means the borrower gets an approval more quickly than with a GP lender. PLP lenders tend to be more experienced with SBA lending than GP lenders.
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Where Do You Go to Find an SBA 7(a) Lender?
Here are a few ways to start the process:
Banks and Credit Unions
One of the best ways to start is with your bank or credit union. Not all banks and credit unions offer SBA lending, but it’s worth checking. Don’t forget to try your credit union if you only use them for your personal banking; many now offer business lending. Start building a relationship with your business banker as early as possible. Many times, borrowers start talking with a lender or apply when they aren’t ready for a loan. Your lender can help you identify ways to prepare your business to be eligible for a loan.
The SBA Lender Match is a tool to help you find lenders offering SBA-backed funding. You answer a few questions about your business and then receive an email in two days with contact info for lenders who expressed interest in your loan.
7(a) & 504 Lender Report
The 7(a) & 504 Lender Report can help you find lenders in the state where your project is located. This report summarizes SBA loan approvals by state and lender. You can filter by project state, program, processing method, and fiscal year. The processing method filter allows you to find 7(a) PLP lenders.
Local Assistance Locator
Another option is the SBA’s Local Assistance page. These SBA partners don’t make loans but provide valuable information about SBA loans. I explain more about them and other SBA resources in my article on SBA small business resources.
Is SBA 7(a) funding right for you?
The SBA 7(a) program has provided valuable funding for decades to small businesses. This article has given you an outline of the 7(a) program as of December 2022. However, the 7(a) program, like all SBA programs, is constantly changing. Talk with an SBA lender to get the most recent information. These lenders, SBA business partners, your CPA, or other business advisors can help you decide if a 7(a) loan is right for your business.
I wish you the funding for your company to thrive. I wish you well.
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