Pros and Cons of SBA Loans: 3 Things That Are Great, and 3 That Aren't
3 Pros to SBA Loans:
No collateral necessary
Lower interest rate
Lower down payments
3 Cons to SBA Loans:
Longer approval times
Borrowing restrictions
Good credit needed
Are you debating the pros and cons of SBA loans? Ask yourself the following questions:
Is my credit score decent?
Can I wait a little longer for my loan?
Do I have an established business?
If you answered yes to these questions, an SBA loan may be right for you. On the other hand, there are problems with SBA loans. This program may not be the best choice if you're a startup (even though startups can get SBA funding with additional requirements), if you need a faster loan, or if you have a lower credit score.
This article will highlight the benefits and drawbacks of SBA loans. Read further to learn about SBA loans.
The Pros
1. No Collateral Necessary
If you apply for a loan through a non-SBA lender, loan reps may require collateral that's equal to or greater than the loan amount. Collateral can be anything of value, such as a house or boat.
If you default on the loan, lenders can seize the asset. With an SBA loan, however, lenders usually don't require upfront collateral. If they do require collateral, the amount is usually small.
Since the government is backing the loan, lenders feel reassured when approving your application. Therefore, they're less likely to ask for collateral.
Here is a step-by-step guide on how to get an SBA loan.
2. Lower Interest Rates
SBA loans offer some of the lowest interest rates within the small business lending world. Overall, an SBA loan interest rate is around 5%. However, the rate depends on several factors, such as:
Your credit history
The lending institution
The amount borrowed
Let's say you're getting a 7(a) loan. If you borrow less than $25,000, and you intend to pay it off in seven years, you could have an interest rate of 7.50%. Conversely, if you borrow more than $50,000, and you intend to pay off the loan in over seven years, lenders could offer a 6% rate.
The SBA mandates lower interest rates to keep costs low for borrowers. Additionally, SBA lenders are content offering lower interest rates because these loans aren't high risk. Since the SBA is guaranteeing a portion of the loan, lenders don't mind offering loans with lower interest rates.
3. Lower Down Payments
SBA loans offer lower down payment requirements. With a 7(a) loan, the down payment must be 10% of the loan balance.
Example: If you're borrowing $400,000, the down payment is $40,000.
That said, the down payment amount could be 15% for startup enterprises. Companies engaging in mergers or acquisitions may have to place a higher down payment as well.
The amount largely depends on the lending requirements. Some lenders may even require some collateral as part of the down payment.
The Cons
1. Longer Approval Times
If you're looking for fast loan approval from the SBA, you may want to look elsewhere. SBA loan processing can take anywhere from 30 to 60 days. In some cases, the process could take up to 90 days. The time depends on how fast the lender processes the loan.
On the plus side, processing times are faster through the SBA Express Program. This program is a trimmed-down version of the 7(a) program where borrowers can borrow up to $350,000. Since you're borrowing a lower amount, the approval times are typically faster.
To speed up the processing times, ensure that you have all the necessary paperwork in order. If you're purchasing real estate, make yourself available to appraisers to expedite the process. If real estate isn't involved, you stand a good chance of faster approval.
Above all, the processing times depend largely on the lender's experience with SBA loans. Experienced lenders will generally streamline the process faster than inexperienced lenders. Therefore, do some research on each lender to root out new SBA lenders.
2. Borrowing Restrictions
Many lenders don't care how you use the funds, so long as you pack back the loan on time. However, the SBA imposes limits on how borrowers can use the funds.
Example: The 7(a) program forbids the purchase of investment properties, such as houses or duplexes. If you want to invest in commercial real estate, you must apply through the 504 loan program, and this program has various restrictions.
SBA loans are primarily for small business owners. They're generally not for investors looking to make risky investments.
3. Good Credit Needed
An SBA loan program offers flexible terms, but it's not for business owners with bad credit. If you want to get a 7(a) loan, you'll need a minimum score of 640.
However, a minimum score doesn't mean you'll get approved. To increase your chances of approval, you'll need a score of at least 680.
The SBA doesn't mandate a minimum credit threshold, but lenders generally prefer scores in the mid 600s or higher. Getting an SBA loan may be an issue if you don't have a credit history, or if you're a startup with a small credit history.
Additionally, you must be concerned about minimum business scores. Whereas personal credit scores stretch from 300 to 850, business credit scores are on a scale from 0 to 300. In most cases, lenders look for a minimum 140 score. Some lenders even prefer scores of at least 160.
Pros and Cons of SBA Loans: Are They Worth It?
The pros and cons of SBA loans depend on your situation. An SBA loan offers lower interest rates, minimal down payments, and no collateral. However, SBA loans are only accessible to those with higher credit scores.
Moreover, borrowers must contend with restrictions that determine how they can use the funds. Also, SBA loans take longer to process than most loans.
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