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SBA Loans: Pros and Cons Guide

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SBA loans are often considered the most beneficial small business financing option as they typically offer high borrowing amounts at low cost. Despite the advantages of government-backed loans, they come with their share of disadvantages.

With so many small business financing options available today, it’s challenging to pick the best option. SBA loans offer the lowest cost business financing, but you’ll have to go through stringent government requirements, and it takes a long time to fund the loans.

If you’re considering an SBA loan, you should know all the pros and cons before starting the application process. This guide will cover the benefits and drawbacks of SBA loans, how to apply, and help you decide if it’s the right lending option for your business.

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    What are SBA Loans?

    SBA loans are government-backed small business financing packages that offer some of the best benefits available on the market. The US Small Business Administration (SBA) governs the program and sets rules and regulations for participating lenders.

    The SBA does not underwrite or fund the loan. Instead, small business owners apply to one of three SBA-approved lending institutions: commercial banks, credit unions, or alternative business financing facilitators (like United Capital Source).

    While it doesn’t fund the loans, the SBA partially guarantees loans (up to 85%). The government guarantee provides extra security for the lender. Since they take less risk, lenders can offer higher borrowing amounts at lower interest rates and longer terms than other small business loan options.

    The SBA takes further actions to reduce financing costs by capping the maximum interest rates and limiting the fees lenders can charge. Lenders must apply for SBA approval and are subject to SBA oversight.

    What types of SBA Loans are available?

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    The loan program includes several lending packages to help meet the diverse needs of small business owners. Let’s look at some of the packages available.

    SBA 7(a) Loans

    The SBA 7(a) loan is the most common financing package in the program. Borrowing amounts go up to $5 million with repayment terms of 25 years for real estate and 10 years for all other loans. The program also includes CAPLines of credit, which carry terms of seven years.

    Interest rates depend on the loan amount, maturity, and whether it’s a fixed or variable rate. The maximum variable interest rate is the prime rate + 4.75%, and for a fixed rate, the maximum is the prime rate + 8%.

     SBA CDC/504 Loans

    The SBA 504 loan program provides funding for major fixed assets. It requires working with a Certified Development Company (CDC). The maximum borrowing amount is $5 million or $5.5 million for special energy projects, not to exceed $16.5 million for three such projects.

    Businesses can use SBA 504 loan proceeds for purchasing real estate, equipment, and machinery or make renovations such as adding a curb or parking area. Real estate loan terms go up to 25 years, and all other loans go up to 10 years. Interest usually does not exceed 3% of the loan amount, and most loans carry an average APR of 5%-6%.

    SBA Microloans

    The Microloan program is the only SBA lending package specifically for startups and newer businesses. All other loans require a minimum of two years in business. Business owners can use the funds for working capital, real estate, and equipment but cannot use the funds for refinancing business debt. Loan amounts go up to $50,000 with a maximum borrowing term of 7 years. Interest rates are usually between 5%-7%.

    Disaster Loans

    SBA disaster loans are available for small businesses impacted by a natural disaster. Economic Injury Disaster Loans (EIDL) are the most common disaster loans for small businesses. Business owners can also apply for a physical damage loan to cover costs that insurance and other programs won’t cover.

    Disaster loans have a maximum borrowing amount of $2 million, and terms go up to 30 years. Repayments are deferred for the first 12 months. Interest rates on EIDL loans cannot exceed 4%.

    What are the pros of SBA Loans?

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    You’ll sometimes hear SBA loans called the “gold standard of small business financing.” Let’s look at what makes them so desirable.

    Government Guarantee

    In most business financing arrangements, the loan is based solely on your personal and business financials and qualifications. With SBA loans, the government acts almost like a cosigner on the loan, as the SBA guarantees a certain percentage of the loan. If the borrower defaults, the government pays the lender for the guaranteed portion. That added security creates options that aren’t available with other loans.

    Borrowing Amounts for Any Budget

    Lenders have more security to offer high borrowing amounts. For comparison, some lenders only provide up to $250,000. With a $5 million maximum, small business owners can make significant investments in growth.

    However, if your business does not need a massive loan, there are also smaller loan amounts available. The wide range of available borrowing amounts means there’s a loan to fund most business needs.

    Low Interest Rates & Limited Fees

    The SBA sets maximum interest rates that limit what lenders can charge. Since the government agency partially guarantees the loans, lenders take less risk and can offer lower rates than the maximum in many cases.

    The SBA also sets limits on the fees lenders can charge. You won’t have to worry about extraneous costs such as application fees. You will have to pay a guarantee fee on the portion of the loan the SBA guarantees, however.

    Manageable Payment Terms

    You’ll have longer to pay off a loan through the SBA than other forms of small business financing. With terms of up to 10 years or 25 years for real estate, you can keep your monthly payment low and have more cash flow for other business expenses.

    Various Business Purposes

    Among the different SBA lending packages available, the loans provide funding for virtually any business need. The 7(a) loan provides a wide range of funding, but there are specialized loans as well.

    There are specifically designed export loans for growing an export business, microloans for startups and new businesses, and the Community Advantage pilot program provides funding for businesses in underserved areas. In addition, SBA express loans can provide faster funding, although they carry lower borrowing amounts and higher interest rates.

    Build Business Credit

    SBA lenders are required to report to the appropriate credit bureaus, meaning paying off your loan can improve your credit score. An improved credit score can help you secure additional financing at lower costs when you need it.

    Combination Financing

    It’s possible to combine an SBA loan with other loans. Combined financing creates more options for your business to expand, invest in new opportunities, or fund a specific project.

    What are the cons of SBA Loans?

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    While there are numerous advantages to the loan program, there are drawbacks you need to know.

    Stringent Approval Requirements

    For the most part, you’ll need an excellent credit score, established business history of at least two years, and strong annual revenue to qualify. Some loan packages are available for lower credit scores or newer small businesses but usually have smaller borrowing amounts and potentially high interest rates.

    Different Requirements for Different Lenders

    A challenging aspect of the program is that the SBA does not set concrete requirements outside of its basic eligibility rules. That leaves each SBA lender to set different underwriting requirements.

    That often makes it difficult to know when you qualify and where. It’s not uncommon for small business owners to have to submit a loan application to multiple lenders before finding one that accepts them.

    Exhaustive Documentation

    SBA loans require in-depth documentation for both personal and business finances. You’ll need to prepare multiple years’ worth of personal and professional tax returns and income statements. In addition, you’ll need to provide business licenses, deeds, leases, and complete SBA forms, and lenders might require additional documents.

    Long Funding Time

    The application process takes a long time, especially with the paperwork and documentation involved. SBA-approved lenders must submit the application to the SBA, which then decides if it will guarantee the loan. If you work with an SBA-preferred lender, it doesn’t need SBA approval and can speed up the process.

    Even after SBA approval, the lender must approve and underwrite the loan. All told, it could take between 60-120 days to close and fund an SBA loan. For comparison, there are some online loans you can apply to in minutes and receive funding the next day or even the same day.

    Down Payment

    Most SBA loans require you to include a down payment, which the SBA calls an equity injection. In most cases, the down payment is 10% of the loan amount. The SBA prefers to work with businesses willing and able to invest in themselves. In this way, all three parties – the SBA, the lender, and the borrower – put some risk in the loan.

    Personal Guarantee

    Nearly all SBA loans require a personal guarantee, which is essentially a legally binding promise to repay the loan. If a borrower defaults on the loan, the lender and the SBA can pursue personal assets to cover the loss.

    Collateral

    Loans under $25,000 typically don’t require collateral. Loans over $350,000 must be “collateralized to the maximum extent possible.” For loans between $25k-$350k, the SBA instructs lenders to follow their collateral policy for non-SBA loans with a similar lending amount.

    Restricted Industries

    The SBA prohibits the following types of businesses from the loan program:

    • Real estate investment firms.
    • Companies engaged in speculation.
    • Gambling businesses such as casinos.
    • Rare coin and stamp dealers.
    • Multilevel marketing (pyramid scheme) businesses.
    • Religious businesses, charities, and other nonprofits.
    • Government agencies.
    • Lending institutions.

    SBA Loans Pros & Cons Summarized

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    Here’s a quick summary of the pros and cons.

    Pros:

    • The US Small Business Administration partially guarantees the loans.
    • Available borrowing amounts between $0-$5 million.
    • Low interest rates and favorable repayment terms.
    • There’s a loan package available for virtually any business need.
    • You can use them to build business credit.
    • It’s possible to combine an SBA loan with other small business loans.

    Cons:

    • Usually requires an excellent credit score & strong business financials.
    • Specific requirements vary between SBA lenders.
    • Requires extensive documentation as part of the application process.
    • It could take up to 120 days to close and fund an SBA loan.
    • Most loans require a down payment & personal guarantee.
    • You may have to offer up collateral to secure an SBA loan.

    Who is eligible for an SBA Loan?

    The SBA’s basic eligibility requirements are:

    • Be a for-profit business.
    • Do business and be physically located in the US or its territories.
    • Have invested personal time and money in the business.
    • Exhaust all other financing options (SBA loans are last resort financing.)

    Each lender sets its own qualifications. Approved businesses we work with here at UCS typically meet the following minimum qualifications:

    • Credit score of 650+ (some lenders say 680+).
    • $360k in annual revenue.
    • Two+ years in business.

    Cash Flow

    In its guidelines, the SBA states:

    “The cash flow of the Applicant is the primary source of repayment, not any expected recovery from the liquidation of collateral… If the Lender’s financial analysis demonstrates that the Applicant lacks reasonable assurance of repayment in a timely manner from the cash flow of the business, the loan request must be declined, regardless of the collateral available or outside sources of repayment.”

    Simply put: You must have the cash flow to support the payments on the loan.

    How to apply for an SBA Loan:

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    United Capital Source can help you apply to an SBA-approved lender following these steps.

    Step 1: Ensure You Qualify.

    You’ll need a credit score between 650-700 and a healthy, consistent cash flow. How you intend to use the money plays a significant role as well. You’ll need a detailed plan of how the funds will help you invest in and grow the business.

    Step 2: Gather Your Documents.

    Be prepared to provide:

    • Driver’s License.
    • Business license or certificate.
    • Voided Business Check (for business bank account information).
    • Bank Statements.
    • Credit Report/Statement of Personal Credit History.
    • Business Tax Returns.
    • Credit Card Processing Statements.
    • Personal Tax Returns – 3 Years.
    • Business Tax Returns – 3 Years.
    • Business Plan (Not in all cases).
    • Personal Financial Statement.
    • List of Real Estate Owned or Business lease if applicable.
    • Debt Schedule/Loan/Rent/Lease Documentation
    • Deeds/Title/Ownership documentation for any collateral/Security
    • Current Profit & Loss Statements and Balance Sheet Year-to-Date
    • A/R and A/P Reports
    • United Capital Source 1 Page Application

    Step 3: Fill Out the Application.

    You can begin the application process by calling us or filling out our one-page online application. Either way, you’ll be asked to enter the information from the previous section along with your desired funding amount.

    Step 4: Speak to a Representative.

    Once you apply, a representative will reach out to you to explain the repayment structure, rates, and terms of your available options. This way, you won’t have to worry about any surprises or hidden fees during repayment.

    Step 5: Receive Approval.

    SBA Loans through our network generally take 3-5 weeks to process. Once approved and your file is closed, funds should appear in your bank account in a few business days.

    Frequently Asked Questions

    Here are the most common questions about SBA loan pros and cons.

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    Since SBA loans are not a one-size-fits-all business financing option, they won’t be the right move for every business. While they offer the lowest cost financing, the long funding times and high approval requirements exclude many companies. The loans only have a 25% approval rate at large banks and a 49% approval rate at small banks, so most applicants have to look for financing elsewhere.

    Another reason an SBA loan might not be the best option is if you need the money sooner. As a small business owner, you’re most likely considering a business loan to take advantage of new opportunities, expand your business, upgrade equipment, or cover working capital needs. Waiting weeks or months might not be possible if the business need is more urgent.

    That being said, if you do meet the requirements and have the time and patience to deal with the lengthy application and approval process, the SBA loan program is probably the best option.

    Can I get an SBA Loan program with bad credit?

    No, SBA loans usually require good to excellent credit. There are a few SBA loan programs for borrowers with low or no credit, but they typically have lower borrowing amounts, high interest rates, and other specific requirements like opening a business in an underserved area.

    If you need business financing, but don’t have the credit or meet the specific circumstances for an SBA loan, consider bad credit business loans. While these loans will have a higher interest rate, you could use them as bridge financing while repairing or building your credit.

    What are my other Small Business Loan options?

    If you determine that SBA loans are not right for your business after reviewing the pros and cons listed above, you might be wondering about other small business options. Luckily, there is no shortage of financing options to meet your specific business needs.

    With the growth in alternative online lenders powered by fintech advances, you can find business financing with flexible requirements and lightning-fast funding. Consider one of these small business loans for your needs:

    SBA Loan Pros & Cons – Final Thoughts

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    In many ways, SBA loans are the most advantageous small business financing options on the market. You can borrow up to $5 million and get a low interest rate and the most extended terms to repay the loan.

    While the low cost and lower monthly payment are attractive options, SBA loans are also the most time-intensive application process, and there’s no guarantee you’ll get approved. Less than half of SBA applications receive approval.

    Ultimately, you must decide if your business can afford to wait for the long underwriting and funding time while risking not getting approved or if the higher cost of a quick funding time and lower approval threshold is worth it.

    Contact us if you’re ready to apply for an SBA loan or pursue another small business financing option. Our loan experts can help you find the best funding package for your business needs.

    We will help you grow your small business.

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