The Most Common Misconceptions About 504 Loans

The U.S. Small Business Administration’s 504 loan product is probably the best financing tool for small businesses acquiring commercial real estate. It provides long-term financing (more than five years) for long-term assets, requires a very low down payment from the business, and provides either a 10- or 20-year fixed interest rate. 

A bank typically loans 50 percent on a 504 project and receives a first lien on the property being financed. The SBA, through a local certified development company, loans 40 percent on the 504 project and takes a second lien on the property, and the borrower is required to supply at least a 10 percent down payment.

Some businesses, and their lenders, are sometimes hesitant to recommend the 504 loan product because of either inexperience or perceived misconceptions about the product. Here are some of the most common misconceptions:

Misconceptions Among the Businesses

Too much paperwork // The paperwork unique to the SBA 504 loan is relatively insignificant (approximately five forms for the borrower to fill out) compared to the total paperwork involved in any real estate deal. Real estate deals are paperwork intensive regardless of SBA’s involvement—almost all real estate projects involve a real estate contract, a valuation opinion, an environmental investigation, a title history examination report, mechanical inspections, city zoning or permitting, and an engineering survey.

The SBA process is too slow // For the last several years, SBA 504 loans have been reviewed at a central processing center that has achieved some incredible efficiencies. The 504 loans are usually processed by the SBA within three to five business days. Not bad, considering the SBA approves 8,000 504 loans a year.

SBA fees are too expensive // There are fees on the 504 loan product that amount to about 1.5 percent of the total project costs. The borrower, in return for the fees, benefits from a fixed interest rate for 10 or 20 years, the option to not refinance the real estate loan for at least 10 years (and avoid all the associated refinance costs), and the ability to minimize the down payment associated with a real estate purchase. A borrower should analyze the cost of the 504 fees and the advantages associated with them.

Misconceptions Among Banks and Lenders

The bank interest rate must be fixed for 10 years // A bank can negotiate any type of interest rate structure it desires (as long as it is allowed by law). It only has to provide at least a 10-year maturity. In today’s market, banks are typically fixing interest rates for three to five years, and then resetting the rate after the initial interest rate term tied to some index (i.e. prime, five-year T-Bill).

Too much paperwork // The bank has to supply one document for an SBA 504 loan application—a commitment letter.

The bank does not have SBA-trained staff to participate in the 504 loan product // While SBA lending experience is always beneficial, it is certainly not necessary. The 504 product, unlike other SBA financing products, is delivered by a local certified development company, not a bank. The bank can process its loan like any other conventional bank loan. The certified development company has the fiduciary responsibility to the SBA, not the bank, so SBA-trained personnel at the bank level are not needed.

Small businesses have fewer financing options than larger companies to access capital. For fixed asset acquisition, the SBA 504 loan offers benefits usually not available to small businesses through conventional channels.