SBA 7(a) vs. 504 Loan: Which Is Right for Your Business?

SBA 504 loans and SBA 7(a) loans are small-business loans guaranteed by the U.S. government and issued by financial institutions, usually banks. SBA 504 loans are used to finance real estate purchases or renovations. SBA 7(a) loans can provide businesses with working capital.

If you need a loan for anything other than a real estate or equipment purchase, an SBA 7(a) loan is your best bet. They can be used for a much wider variety of purposes, including working capital and business expansion. While property development might be part of that, it doesn’t have to be.

If you’re financing a real estate or equipment purchase, you can choose between an SBA 7(a) and 504 loan. Here are the key similarities and differences.

SBA 7(a) vs. 504 loan comparison: Which is right for you?

Both 7(a) and 504 loans can be good options for many types of businesses, and for some, the decision might be a toss-up. But business owners with any of the specific conditions below might want to lean toward one or the other:

Choose the SBA 7(a) loan if:

• You need working capital to buy inventory or supplies or to fill cash flow gaps.

• You need to finance real estate or equipment, but don’t meet the job creation or public policy goal requirements for an SBA 504 loan.

• You prefer a faster SBA loan application process.

• You can handle a variable interest rate.

• You can provide collateral.

Choose the SBA 504 loan if:

• You need financing to purchase, lease, renovate, or improve commercial real estate, buildings, or equipment.

• You’re able to show that you meet job creation, job retention or public policy goals.

• You can handle a slower loan application process.

• You prefer a fixed interest rate.

• You prefer for the asset you’re financing to serve as collateral.

» MORE: Compare the best large business loans

SBA 504 loans vs. SBA 7(a) loans: Key differences

» MORE: Can you have multiple SBA loans?

SBA 7(a) loan: Best for general business financing

For most small-business owners who need general business capital, the SBA 7(a) loan is the best option. The SBA 7(a) loan is a flexible, low-interest-rate business loan that’s suitable for a variety of business needs.

Any of the following are also eligible uses for an SBA 7(a) loan:

• Purchasing, constructing or renovating a commercial property (most investment property is excluded, however).

• Acquiring fixed assets, such as equipment, fixtures or furniture.

• Working capital, such as purchasing inventory or supplies.

• Purchasing land for a business.

SBA 7(a) loan eligibility

Any U.S.-based business that meets the SBA’s definition of "small" — which varies based on industry — can apply for an SBA 7(a) loan. You'll also need to demonstrate that you've invested in the business, and your lender will have additional requirements.

SBA 7(a) loan interest rates and fees

SBA 7(a) loans can have fixed or variable interest rates. The latest SBA loan rates represent a spread over the prime rate, which is a market rate that fluctuates based on government action.

SBA 7(a) loan rates are similar to the rates on conventional bank loans and represent some of the most affordable options for small businesses.

The primary fee on an SBA 7(a) loan is the SBA guarantee fee. The SBA charges the guarantee fee to ensure that the government has money to reimburse the lender if the business can’t pay back the loan. The lender may pass it on to the borrower.

SBA 7(a) loan collateral

Most SBA 7(a) loans require collateral of some sort. For loans of more than $50,000, the SBA requires the lender to use their collateral policies for similarly-sized non-SBA commercial loans.

Lenders may secure the loan by placing a lien on all assets that are financed with the loan, as well as any existing fixed assets of the business. If the loan isn’t fully secured at that point, the bank might also place a lien on the business owner’s personal residence or other personal property.

In addition to collateral, anyone who owns 20% or more of the business must sign an SBA loan personal guarantee.

SBA 504 loan: Best for financing fixed business assets

The SBA 504 loan, formally called an SBA 504/CDC loan, is a more specialized loan than the 7(a) loan. The 504 loan is designed for business owners who need to finance the acquisition or improvement of fixed assets like land, buildings or equipment and whose projects promote economic development or other public policy goals.

The SBA 504 loan has a more complicated structure than the SBA 7(a) loan, comprising three parts:

• Bank loan (50%): A bank or other direct lender extends 50% of the loan amount.

• CDC loan (40%): An SBA-approved Certified Development Company, or CDC, extends 40% of the loan amount.

• Borrower down payment (10%): The borrower puts up 10% of the loan as a down payment.

CDCs are local nonprofit lenders that promote economic development in their communities by participating in SBA 504 financing. The SBA certifies and regulates CDCs.

The typical business owner has to put 10% down on an SBA 504 loan. However, if you have fewer than two years in business or are building a property that can be used for one purpose only, like an amusement park or gas station, you’ll have to put down 15%. If your business checks both boxes, the down payment increases to 20%.

The funds from a 504 loan cannot be used for investment properties. If you’re financing new construction, at least 60% of the building must be owner-occupied as soon as construction is complete and only 20% of the space can be leased long-term.

SBA 504 loan eligibility

For every $90,000 that the CDC lends, the applicant business must create or retain at least one job. This number rises to $100,000 in special geographic areas and empowerment zones and to $140,000 for small manufacturers — meaning businesses that meet those requirements have to create fewer jobs overall than those that don’t.

If you’re not able to show that you meet the job creation or retention requirements, there are other public policy goals that you can meet instead, such as furthering the growth of minority or women-owned businesses or reducing energy consumption.

SBA 504 loan interest rates and fees

SBA 504 loans are fixed-rate loans. Their interest rates are pegged to the rates on U.S. Treasury bonds.

There are a few more fees on SBA 504 loans compared with 7(a) loans. The borrower has to pay an upfront guarantee fee, an annual service fee, and CDC processing and servicing fees.

SBA 504 loan collateral

Most SBA 504 loans are self-secured, meaning that the underlying fixed assets serve as collateral.

Anyone who owns 20% or more of the business must sign a personal guarantee on SBA 504 loans. Even business owners with a solid credit history and excellent financials will have to sign a personal guarantee for the lender's security.

» MORE: SBA loan collateral requirements