SBA 504 Loans: The Complete Guide

What is an SBA 504 loan?

The SBA’s 504 loan program provides long-term financing for real estate, equipment, and other fixed assets. These loans are partially funded by Certified Development Centers (CDC), certified through the SBA.

The maximum loan amount is $5 million, though there are exceptions for specific energy projects. In this case, a borrower can receive $5.5 million per project for up to three projects not exceeding $16.5 million.

What are 504 loans used for? 

SBA 504 loans are designed to promote business growth and job creation through the purchase of real estate or other long-term assets. They can be used to purchase the following long-term assets:

• Existing real estate or land
• New facilities
• Long-term equipment and machinery
• Updates to new or existing real estate
• The improvement of land, streets, utilities, and parking lots

However, a 504 loan cannot be used for speculative real estate investments, working capital, or inventory. 

How SBA 504 loans work.

To complete an SBA 504 loan, there will be three parties involved:

• A Certified Development Company (CDC) – SBA-certified companies that are authorized to issue 504 loans
• A third-party lender – A bank or credit union
• The borrower – The small business owner

The small business owner applies with a Certified Development Company. The CDC coordinates a two-part mortgage between the borrower, the SBA, and a third-party lender. Fifty percent of the loan will function as a conventional commercial mortgage through a lender such as a bank or credit union. A second mortgage backed by the SBA will cover up to 40% of the loan. The remaining 10% is contributed by the owner as a down payment.

Newer businesses, defined as a business that has been in operation for two years or less, must contribute a 15% down payment. If the loan will be used to purchase or build a limited or special-purpose property, you will also need a higher down payment. The SBA defines special purpose properties as those with a unique design that restricts its use for other purposes such as a bowling alley.

How to apply for an SBA 504 loan?

Applying for a 504 loan is a bit different since the loans are only available through CDCs. You’ll start by finding a CDC location in your area—more than 200 centers are located across the U.S.

Once you’ve found a CDC, you need to get prequalified to see what your business is eligible for. Getting prequalified won’t hurt your credit score, and the process is much less rigorous than the full application process.

Once you’re ready to submit a formal loan application, you can use the 504 Authorization File Library to see what documentation you need. It typically takes the SBA about a week to approve or deny your application, but it could take several months to close on the loan and receive the funds. 

Eligibility requirements for a 504 loan.

You must meet the following requirements to qualify for a 504 loan:

• Operate as a for-profit company 
• Do business in the United States or U.S. territories
• Have a net worth below $15 million
• Have an average net income below $5 million after taxes for the two years prior to your application
• Have hazard insurance on the property being financed

In addition, borrowers have to meet general eligibility standards set by the SBA.

Pros and cons to consider

When evaluating whether a 504 loan is the right choice for you, consider the following pros and cons.

Pros

• Low interest rates – Interest rates on the CDC portion of the loan are limited by the SBA, so they tend to be lower than what most lenders offer. And the interest rate is fixed, so it won’t change throughout the life of the loan. 
• Lengthy repayment terms – SBA 504 loans also come with generous repayment terms. If you purchase equipment, you’ll have a 10-year repayment term. But real estate comes with 10-, 20-, and 25-year repayment terms.
• Low down payment requirements – When you take out a 504 loan, you’re required to pay a 10% down payment which is lower than what most commercial lenders require.  

Cons

• Comes with a personal guarantee – The SBA requires a personal guarantee on all of its loans, including 504 loans. A personal guarantee means the lender has a right to pursue the owner for loan repayment if the business defaults on the loan. 
• Rigorous application process – The SBA is known for its extensive documentation requirements—it could take a couple of months to close on the loan and receive the funds.

Can a SBA 504 loan be used for a change of ownership?

A 504 loan may be used to finance the purchase of eligible, long-term, fixed assets as part of a business acquisition. The purchase of any ineligible assets must be financed through other means such as an SBA 7(a) loan.

SBA 504 loan alternatives

If you’re unsure whether a 504 loan is the best option for your business, there are other options you can consider. Here are a few SBA 504 loan alternatives:

• SBA 7(a) loans – An SBA 7(a) loan is another loan that’s backed by the SBA. These loans are typically used for working capital, equipment, and refinancing business debt. Loans are available for up to $5 million with repayment terms up to 25 years.  
• SBA Express loans – SBA Express loans are available for up to $500,000, and the rates may be slightly higher than other types of SBA loans. But the turnaround time is less than 36 hours, so it’s a good option for anyone looking for faster funding.