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SBA 7(a) Loans: The Pros & Cons

If you’re a small-business owner looking for capital to expand, you’ve likely come across SBA 7(a) loans – the nation’s most popular type of loan offered through the U.S. Small Business Administration (SBA).

One common misconception is that the SBA lends directly to small-businesses.  In reality, the SBA 7(a) Loan Program partially guarantees loans made by banks or other direct lenders to eligible small-businesses.  The program aims to promote economic growth by encouraging lenders to partner with small-businesses that may be struggling to secure financing on reasonable terms.  Because of the guaranty, SBA loans tend to have lower monthly payments than other types of loans.  However, there are some drawbacks that must be considered prior to getting started with your application.

To help determine if a 7(a) loan is right for your business, let’s review the pros and cons, starting with some background on what makes these loans popular:

Pro #1 – Long Repayment Terms
The program offers fully amortizing terms up to 10 years on non-real estate transactions (i.e. working capital, equipment or inventory purchases, etc.).  Longer maturities result in drastically lower monthly payments and conservation of cash flow, creating an opportunity to grow your business faster.  In addition, the program allows you to refinance existing debt that may be too expensive.

Pro #2 – Low Interest Rates
As opposed to online short-term loans which tend to have extremely high rates, the SBA sets maximum interest rates that lenders can charge on 7(a) loans.  The maximum interest rate is determined by the size of the loan but typically will not exceed 8.25% (WSJP + 2.75% as of March 31, 2019).

Pro #3 – No Collateral Requirements
The SBA guaranty helps offset risk, giving financial institutions the flexibility to consider transactions not fully collateralized by business or personal assets.  When applying for a traditional bank loan, lenders often require a loan to be fully collateralized by real estate or other tangible assets.  Collateral shortfalls are one of the most common reasons credit might not be available elsewhere on reasonable terms, therefore making a small-business eligible to obtain financing through the program.

Con #1 – Documentation Requirements
The application and funding process can appear to be cumbersome and can take up to several weeks (depending on borrower responsiveness).  However, for “small loans” *under $350,000, the SBA prescreens applicants and allows lenders to fast track your application upon meeting certain criteria.

Con #2 – Personal Guarantee
Lenders will require you to sign a personal guarantee if you own 20% or more equity in the business.  If you’re unable to make payments down the road based on the original agreed upon terms, you’ll need to pay back the lender from your personal accounts or assets.

Con #3 – Difficult to Qualify
Personal credit and business financials must be solid.  The SBA guaranty doesn’t make a bad loan good, it simply makes a good loan stronger and is meant to assist credit worthy small-businesses.  While some lenders may only consider 650+ credit scores, others may look at the overall health of your business, including the ability to meet the SBA’s Debt Service Coverage Ratio (DSCR) required minimum of 1.15x.

Although SBA 7(a) loans require investment of time and effort, the overall benefits of the program outweigh the costs for many small-business owners.  If you’re searching for the least expensive and most flexible option, 7(a) loans should absolutely be on your radar.  While factors like timing and the amount of paperwork matter, extended maturities and lower interest rates tend to have the most profound impact on your business long-term.  As when pursuing any business financing option, be sure to do your research and consult a preferred lender or lender service provider to ensure you avoid a less than stellar experience.

About Windsor Advantage, LLC

Windsor Advantage provides banks, credit unions and CDFIs with a comprehensive outsourced SBA 7(a) and USDA lending platform.

Since 2010, Windsor has processed more than $2.3 billion in government guaranteed loans and currently services a portfolio in excess of $1.3 billion (as of May 31, 2019) for over 85 lenders nationwide. With more than 150 years of cumulative SBA and USDA lending experience, cutting edge technology, rigid controls and consistent processes, Windsor is uniquely qualified to assist any size lender with implementing a thoughtful and profitable government guaranteed lending initiative.

Windsor Advantage has a team of 30 professionals with offices in Chicago, Illinois; Indianapolis, Indiana; Seattle, Washington and Charleston, South Carolina.

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