THE SBA LOAN PROCESS AND FACTS
SBA Loan Financing
SBA loan is a government-backed loan that may help with startup expenses, working capital requirements, growth, real estate purchases, corporate acquisitions and construction projects. This financing is issued by a private lender but guaranteed by the federal government. The federal guarantee is generally 75% of the loan amount. If the company sells outside the United States, the guarantee maybe up to 90%.
Community banks commonly make SBA loans. Large bank institutions also make these loans, but the bulk of these loans are community bank financed.
A community bank is a commercial bank that earns from and lends money to the local area where it is located. It is not generally owned or managed by a larger group of banks.
How Much Financing Does SBA Provide?
The SBA 7(a) program has a limit of $5 million that can be borrowed by an individual borrower(s).
This can be comprised of one or more loans but cannot exceed the $5 million limit per borrower.
Any borrower (in a business with a 20% or greater interest) must be a guarantor on an SBA loan. The borrower will need cash, usually 10 to 15%, to meet the bank’s required infusion of funds or equity in the financing collateral. Equity in real estate owned can satisfy this requirement.
If the borrower buys real estate, they must occupy at least 51% of the premises to qualify for an SBA loan. To meet the loan cash infusion, the borrower can negotiate with a seller to take back a note for part of the purchase price. However, the borrower will have to put up at least 5% to have “skin in the game,” as required by the SBA.
If the borrower(s) is buying a business with no real estate, similar scenarios can be used to meet the cash requirement.
If the borrower requests funds for operating capital in an established business, the same concepts for buying a business or real estate apply as stated above.
If the borrower needs the funds for construction, equity in real estate owned may cover the initial upfront cash requirements.
Requirements For Borrowers to Secure a Loan From SBA
Banks may ask for the borrower’s bank statement to see if the money has been in the bank account for at least 90 days before the loan closing to confirm they have the cash reserves in the bank. Money borrowed or gifted undergoes the scrutiny of the bank as to the borrower's requirements to pay it back.
This factors into the total monthly payments to determine if the borrower can make the monthly payments for the loan (DSCR-debt service credit ratio).
Banks have different criteria and appetites for various types of loans. We have established contacts with numerous banks and understand what may be acceptable to them. We can direct the borrower to the right bank and save them time and effort searching for the right bank.
Community banks make these loans because they are generally guaranteed up to 75% by the SBA. The bank funds the loan and can replenish its liquidity for making additional loans by selling the loan to investors.
Interest Rates
The bank makes a premium on the loan when it is sold. The bank continues to service the loan, which means they receive payments from the borrower. Thus, the bank earns income on the sale of the loan in the secondary market and fees from servicing (collecting payments from the borrower).
The SBA guarantee only comes into “play” if the borrower defaults. It is, however, important.
because It enables the bank to find a willing buyer for the mortgage.
These loans have an interest rate based on the established prime rate, plus lender-added points.
The maximum add-on points permitted by the SBA is 2.75%. The individual bank determines the add-on points based on their underwriting requirements. This add-on amount maybe negotiable.
This is a variable rate loan. This variable rate is re-calculated by the SBA every quarter. If the prime rate increases, the add-on points established by the bank are on top of the new prime rate. If the prime rate declines, the variable rate will decline.
Amortization Schedule
The amortization schedule for a loan is ten years if there is no real estate security and up to 25 years if there is real estate collateral. Generally, for the 25-year amortization to be effective, the real estate must be at least 51% of the loan amount.
Some banks will provide a hybrid amortization schedule even if the real estate value does not comprise 51% of the loan amount.
For example, if it is a $2 million loan and the real estate is worth $600,000, the bank may permit a 14-year amortization. This is entirely up to the underwriting bank.
The amortization period is critical because it reduces the monthly payment. Banks will require a debt service ratio of anywhere from 1.20 to 1.25. The debt service ratio is defined as monthly revenue divided by the monthly payment.
Timelines Detail and Some Upfronts
If the amortization of the loan is 15 years or less, there is no prepayment penalty. The individual bank establishes prepayment penalties. Usually, this is over three years and is generally 5,3,1.
The SBA has approved forms that must be completed by the borrower(s) and submitted to the banking institution.
The time from submitting all required documents to the bank to get funding is generally 60 to 75 days.
If the bank preliminarily decides it wants to proceed with the loan, it will issue an LOI (Letter of Intent) containing the terms of the loan the bank will accept.
The borrower must sign and return the LOI within the time designated by the bank and wire the required deposit.
This deposit is to cover the bank's upfront cost. Some banks will return the unexpended balance on the deposit if the loan does not go through.
Depending on the loan size, the deposit is usually $5,000 to $10,000.This covers the cost of appraisals and other out of pocket costs the bank incurs.
SBA Guarantee Fee
The SBA requires a borrower to pay an SBA guarantee fee for the total loan. The guaranteed fee schedule for an SBA loan is as follows:
$150,000 or less = 2%; $150,001-$700,000 = 3.0%; $700,000- $1,000,000 = 3.5%; plus 3.75% on the guaranty portion over $1million
USDA Loan
Another source of funds for a borrower’s business is through the United States Agriculture Department. This is referred to as a USDA loan.
USDA Financing Criterion
USDA financing is available for loans up to $20 or 30 million. It seems “the sweet spot” for banks is about 10 million for a USDA loan.
USDA loans are available only in USDA-eligible areas. This is generally an area that has less than 50,000 population.
USDA publishes a map that, when putting in an address, will show a viewer if the area is USDA eligible
Fundamental to getting either loan, there are several preliminary questions that I like to ask to determine if I am interested in handling a borrower request and think I can be effective and bring value to the borrower(s):
Are you unable to get a loan satisfactory for your purposes from a bank on a conventional basis? This is a criterion established by SBA and USDA for a loan.
What is your credit score? Banks rely heavily on this. The SBA has a minimum of 640 and USDA similar. Some banks will have their own minimum credit score requirements.
Some banks will only make a loan if there is real estate collateral.
Banks may require up to 15% or more in some cases in cash or established equity in real estate, as the borrower's infusion of “skin in the game.” Does the borrower(s) meet this requirement?
If buying or starting a business, what is their experience? Banks rely heavily on experience.
Have you filed for bankruptcy?
Have you been arrested or convicted of a crime?
Based on the borrowers' existing or projected revenue, will they satisfy the bank's debt service ratio?
Based on the borrowers' existing or projected revenue, will they satisfy the bank's debt service ratio?
Is the borrower planning a construction project? Some banks will lend for construction projects, and some will not. Usually, the bank's policy on this is based on the bank's ability to monitor and disperse funds throughout the construction process.
