SBA Loans are perhaps the most well-known kind of business funding in the United States.
The SBA, like any government agency, can be a colorful source of “aid.” Just ask the average disabled veteran about their love/hate relationship with the Veterans Administration.
Following the billions of dollars in damage caused by natural disasters such Hurricane Harvey (the first major hurricane to make landfall in the United States since Hurricane Wilma in 2005) and Hurricane Irma (the first major hurricane to make landfall in Florida since Wilma), the Federal Emergency Management Agency (FEMA) directs homeowners seeking assistance to the Small Business Administration (SBA).
SBA disaster loans can provide some homeowners with generous funding that allows them to fix their property and get back into their homes quickly.
That is fantastic, right? Well…. yes and no.
Many disaster victims, however, have learned (too late) that SBA loans come with a rather important caveat—applying for an SBA loan will make a homeowner ineligible for federal disaster grants later on.
In a September 6 letter to congressional leaders, Louisiana Governor John Bel Edwards requested that language be included in clarifying the Duplication of Benefits (DOB) provision of the Stafford Act “so that the victims of a disaster will not be penalized for making use of SBA disaster loans.“
How a Government Agency Becomes the Main Hub for Small Business Funding Assistance
It is no surprise that the SBA is the first government agency a small business would reach out to following a natural disaster. But the 18,000 Louisiana homeowners Governor Bel Edwards made reference to as being approved for SBA loans and consequently became ineligible for grants is illustrative of a larger problem within the red tape of any government agency.
Make no mistake, the SBA can be an extremely valuable federal organization that helps countless people during very difficult times.
According to the SBA’s 2016 financial report, the agency approved more than 25,000 disaster loans totaling more than $1.4 billion and worked 289 active declarations across the country.
In addition to disaster loans, some of the other types of loan programs the SBA offers include:
- 7(a) Loan Program — The SBA’s most common loan program helps general small businesses get financing and loans can be used for a variety of general purposes;
- Certified Development Company (CDC)/504 Loan Program — CDCs are nonprofit corporations set up to contribute to the economic development of their communities, and the CDC/504 Loan Program provides businesses with loans of up to $5 million; and;
- Microloan Program — The Microloan program offers up to $50,000 for small businesses and certain not-for-profit childcare centers looking to start up and expand.
It is important for all small business owners and entrepreneurs to carefully consider all aspects of a prospective loan, especially when endorsed by a government agency. While an SBA loan can be advantageous for some, such loans can also carry certain drawbacks that can have damaging consequences later on.
Five important factors that any person considering an SBA loan should keep in mind include the following:
Paperwork / Approval Time
The SBA loan approval process involves three steps.
The first step involves getting pre-approval for a loan.
The second step is the formal underwriting.
The final step is the closing.
Because SBA loans are directly funded by lenders and backed by the federal government, a number of documents may be required as part of the application process.
Simply in seeking pre-approval, an SBA loan applicant will need to present a multitude of personal and business financial statements, including tax returns for the prior three years, credit score authorizations, and background checks for all managers and owners. The first part of the process favors businesses that are more established, as lenders can be leery of providing full requested amounts to upstarts.
The pre-approval process alone can take applicants days and weeks to compile the necessary paperwork.
After pre-approval, SBA loan underwriters must maintain contact with the applicant for additional paperwork and verification throughout the process. During the underwriting stage, lenders will be evaluating the applicant’s business experience, analyzing his/her ability to repay the loan, evaluating his/her credit history, seeing whether the borrower has reasonable equity in the business, and confirming that the amount of collateral provided satisfies agency guidelines.
Applicants will have to get very handy creating financial statements and spreadsheets.
Assuming all paperwork is handled properly and is submitted as soon as possible, SBA loan applicants should generally expect the loan process to take at least 2-3 months to complete.
Most SBA loans take longer than 6 months.
Larger loan requests can take longer to evaluate and approve. In most cases, individuals invest several weeks and months’ worth of time into collecting and maintaining documentation only to be denied an SBA loan.
Lenders will often require SBA loan applicants to present some kind of property for collateral. Most SBA loans require homeowners to offer their home and personal possessions as collateral.
The SBA defines collateral as “an additional form of security which can be used to assure a lender that you have a second source of loan repayment.” It may include equipment, buildings, or inventory, but most frequently involves the home of the loan applicant.
Loans greater than $250,000 secured by commercial real estate require certified appraisals, and lenders are required by law to obtain third-party valuation on transactions of $50,000 or more when real estate is being used as collateral.
Owner-occupied residences generally become collateral when a lender requires the residence as collateral, equity in the residence is substantial and other credit factors or collateral sources are weak, the business is being operated out of the same parcel of land, or simply to ensure the applicant will remain committed to the success of the venture.
In more blunt terms: pay back the loan or lose your house along with your business.
The amount of collateral required can be more than many applicants are willing to put forth. In some cases, the amount of required collateral can force businesses to scale down their intended operations or even opt not to open.
7(a) loans guaranteed by the SBA are assessed a guarantee fee that is based on the dollar amount of the guaranteed portion of the SBA loan and the repayment term of the SBA loan. A lender initially pays this fee but has the option to pass it on to the borrower at closing—which is usually the case.
CDC/504 and microloans do not have the same specific guarantee fees, but often have similar origination fees.
Lenders cannot charge separate loan origination fees on SBA guaranteed loans, but they can charge “packaging fees.” The SBA states that those packaging fees “must be reasonable and customary for the services actually performed and must be consistent with those fees charged on the lender’s similarly-sized non-SBA guaranteed commercial loans.”
Some of the other fees that an applicant should anticipate when applying for an SBA loan include:
- Origination fee;
- Draw fee;
- Bank wire fee;
- Check processing fee;
- Loan packaging fee;
- Service fees; and
- Late payment or prepayment fee.
In addition to the fees mentioned above, many lenders will also include closing costs for an assorted number of other processing fees. Virtually all of these fees are worked into an SBA loan and are required to be paid at closing.
For all the hype, an SBA loan is by far one of most convoluted and expensive loans available to entrepreneurs in the United States – and we haven’t even discussed interest rates yet.
SBA loans can have some of the most competitive interest rates among lenders, but certain business loans can also be much higher than traditional loans. SBA loans can be subject to higher interest rates because lenders are ensured that they will receive payment, even if the business defaults.
Not surprisingly, lenders make a lot of money by charging higher interest rates to riskier applicants. Small business owners with lower credit scores may find it difficult to obtain reasonable interest rates.
In some cases, applicants may be much better suited to explore other lending options such as credit card loans. Many credit card companies provide 0% introductory interest rates on purchases and balance transfers. Unsecured lines of credit can allow certain individuals to gain access to much larger credit lines in the future at better and better interest rates.
Access to Extra Money
Ultimately, the decision to take out an SBA loan comes down to what the loan will cost the applicant each month. Even when a business ends up doing well, a bad loan absorbs most of the profits for the term of the loan.
Some businesses may be able to seek additional financing, but this also increases their debt obligations on top of the costs for an SBA loan.
Additional lines of credit can also cause additional problems, and some business owners risk losing everything.
SBA loans can be enormously beneficial for certain types of people, but they are not the best option for most entrepreneurs.
Any business owner who is considering an SBA loan should make sure to seek out the advice of an expert on additional lines of credit. Depending on your specific situation, a better line of credit and lower fees may be negotiated with a different lender.
Again, while the SBA is understandably well-known and trusted, unsecured lines of credit and credit card funding are additional funding sources that deserve consideration and can be extremely beneficial to certain types of business owners.
Peer-to-peer lending (also known as P2P lending or social lending) is another form of debt financing that can provide cheaper lines of credit because such ventures are usually operated online without the overhead typically associated with commercial banks.
If you are seeking a loan for your business, it is in your best interest to fully explore all of your options and work with an experienced financial consultant who can make sure that you obtain the funding you need while minimizing the amount of unnecessary fees and time delays.