Quick Answer: An SBA 504 loan is a fixed-rate, long-term loan for fixed assets such as buildings and major equipment. It combines two loans. A bank or credit union usually funds 50% of the project. A Certified Development Company funds 40%, and the borrower puts in 10%. It cannot be used for working capital, inventory or marketing. Borrowers generally need a 660 credit score or higher and two years in business.

What Is an SBA 504 Loan and How Does It Work?

Small businesses that are needed to make a big purchase or desire to extend their business can avail of such financial support by applying for SBA 504 loan. Besides, there are various other funding options available in the market, Small Business Loans (SBA) loans rise above as the most popular one out of all. 

This loan features attractive benefits to business owners such as lower down payments, interest rates as well better terms that help in increased credit scores for the ones who qualify. However, there are certain important points that one needs to keep in mind before heading toward its lengthy application process. 

If you are considering applying for small business loans for the first time, this article is just for you. So, keep on reading and understand what are SBA 504 loan and How it works in depth. 

1. What are SBA 504 loans?

The 504 loan/ CDC (Certified Development Company) is a loan program that offers fixed-rate, long-term business financing help for fixed assets. This helps in quick financing, creating jobs, and better business growth. 

This loan is funded and issued partly by CDCs that are certified by SBA along with approved funds added by lenders. It helps in covering fixed assets and real estate costs. These loans are the combination of two different loans that are offered by:

  • Non-profit lenders i.e. Certified development companies  
  • Traditional bank 

Both loans i.e. lender’s loan and CDC loan close at the same time but the Certified Development Company loan program is highly preferred by business owners as they offer lower interest rates than traditional banks. 

The minimum loan amount is available for $5 million which can exceed up to $5.5 million. This exceeding amount will be done when the investment is performed for certain energy projects. The funding can be availed for not more than three projects, which means the maximum amount cannot exceed $16.5 million. 

2. What are SBA Loan Requirements?

There are multiple other program-specific eligibility requirements that should be met by the small business owner before applying. These are: 

  • The business net worth must have net worth lower than $15 million 
  • The borrower should have a feasible business plan
  • The borrower should be able to repay the loan  
  • The borrower should not operate for a Non-profit organization   
  • Hold net income lower than $5 million (past 2 years) after tax deductions 
  • The borrower must occupy at least 50% of the property (if existing) and 60% (if newly constructed) 

3. Sba 504 Loan Can Be Used For –

The 504 loans can be used for a range of assets that add value for business growth and job creation. It includes:

1. Construction

  • Addition of a new facility 
  • Equipment and machinery 
  • Construction of existing land or building

2. Renovation or extension 

  • Landscaping, parking lots, street or land construction, garden (adds up to 5%for community improvements) 
  • Expanding existing facilities 
  • Debt refinancing 
  • Loan or interest fee payment 

4. SBA 504 Loan Cannot Be Used For – 

Just like any other loan SBA small business loans also have their limitations considering borrower use. The list of use the SBA loan funds prohibited for: 

  • Product or business marketing and advertising
  • Day-to-day working expenses 
  • Conjectural real estate investments
  • Inventory, supplies, and raw materials
  • Renting properties
  • Working capital

5. How does an SBA 504 loan work?  

The 504 loan program by SBA works by combining two loans-providing parties i.e. 

  • The lender (typically banks) 
  • The CDC

The above contributes to small business growth and exposure that adds value to the country’s growth. 

As per U.S. Small Business Administration, the 504 CDC (Certified Development Company) loan program covers borrowers working capital. Under this:

  • The borrower needs to contribute – 10%
  • Certified Development Company (CDC) contributes – 40% 
  • Bank of Credit Union Financing invests – 50% (rest)

6. The SBA 504 Loan Working

The CDC acts to structure and coordinate finance between both parties i.e., the borrower and the lender. The distribution of cost (in%) will go as per the distribution showcased above (10%, 40%, and 50%) of the project cost. 

  • The conventional first mortgage of the project cost will be from the ‘Lender.’ 
  • The SBA loan-backed portion is the second mortgage for eligible projects by ‘CDC’.
  • The rest is the final contribution that is contributed by small business owners. In certain circumstances, the borrower’s contribution percentage will go up to 20% of the total project cost. 

7. How To Qualify SBA 504 Loan?

In order to qualify for 504 loans, a borrower must need to meet the following qualification requirements:

  •  It is compulsory that the borrower must be registered as a profit organization
  • Should meet the credit score criteria of 660 or higher along with that the applicant should also have a minimum of two years of business history 
  • Should be eligible to qualify (DSCR) Debit Service Coverage Ratio of at least 1.25x.
  • Eligible to pay a downpayment of at least 10% to 20% maximum 
  • The borrower should not be dealing with tax liens, bankruptcies, outstanding government loans, or no due business or personal financial history. 

8. How To Pay Back 504 Loan? 

There are majorly four factors that might impact your repayment terms:

  • Repayment terms – 5 to 10 years can go up to 25 years 
  • Bank fee percentage– One-time fee i.e., 0.5%, accept negotiation 
  • Third-party fee– reports, attornies cost  
  • 504 loans interest rate– 4% to 10% no limit 

In A Nutshell 

Undoubtedly, the SBA 504 loan is an amazing financing option if you are planning to purchase commercial real estate and long-term equipment for successfully operating your business. But it can turn beneficial only when you successfully stand on their eligibility criteria.

If your target and affordability allow you to look for a lower down payment along with a long-term repayment option, then a 504 loan would turn out an easier way for your cash flow. 

Case Study: How I Work Out the SBA 504 Down Payment on a Building

In our experience, the 10% down payment makes 504 loans stand out for owners buying real estate.

I tested this on one sample $1,000,000 building purchase using the 10%, 40% and 50% split in this guide. I priced the CDC portion at an illustrative 6% rate over 25 years. Here is what we found:

  • Borrower share at 10%: $100,000. CDC share at 40%: $400,000. Bank share at 50%: $500,000.
  • If the borrower share rises to 20%, the owner must bring $200,000.
  • The $400,000 CDC portion at 6% over 25 years is about $2,577 per month.

The result: the standard 504 split cut the owner’s cash down payment from $200,000 to $100,000.

Frequently Asked Questions

How is an SBA 504 loan split?

The borrower usually contributes 10%, the Certified Development Company 40% and the bank or credit union 50%. In some cases, the borrower’s share can rise to 20%.

What can an SBA 504 loan pay for?

It covers fixed assets such as new facilities, equipment and machinery, construction and expanding existing facilities.

What can I not use an SBA 504 loan for?

You cannot use it for working capital, day-to-day expenses, inventory, marketing, renting property or speculative real estate.

What credit score do I need for an SBA 504 loan?

Borrowers generally need a credit score of 660 or higher and two years in business. They also need a debt service coverage ratio of at least 1.25x.