SBA 7(a) vs. 504 loans
The Small Business Administration (SBA) has a variety of loan programs. These are some of the best business loans available because the SBA guarantees them. This means you may have access to more competitive rates and other benefits that standard business loans might not offer.
For many businesses, you will choose between two loan programs, the 7(a) and 504 loans. 7(a) loans are designed for everyday working capital, while 504 loans are meant to finance equipment and commercial real estate.
Because they serve different purposes, you should familiarize yourself with both options to determine which suits your business best.
Key takeaways
7(a) loans cover working capital and frequent business expenses
504 loans cover equipment or real estate financing
Loans available up to $5.5 million with 10- to 20-year terms
Collateral and down payment are required for both options
What is an SBA 7(a) loan?
SBA 7(a) loans are the most common option for business owners because they provide flexible funding for various business needs. Generally, you can use a 7(a) loan for working capital, equipment or other expenses. The application process is similar to standard bank loans, although it may take longer to process if you don’t apply through the Express program.
Because the SBA guarantees them, 7(a) loans have competitive interest rates — both fixed and variable. However, their low rates mean that you must meet strict eligibility criteria. In many cases, you may also need to provide collateral to secure your loan.
Your business will need to make a down payment of 10 percent to 30 percent of the total loan amount. Depending on the size of your loan, you may pay a guarantee fee or other fees set by your lender.
But despite the fees, down payment and strict requirements, 7(a) loans are one of the most sought-after ways of financing a business.
SBA 7(a) requirements
To qualify for a 7(a) loan, you will need to meet a few basic requirements set by the SBA:
For-profit business based in the U.S
Reasonable owner-invested equity
Exhausted other financing options and personal assets
Considered a small business based on SBA size standards
Collateral required for loans above $350,000
Lenders will also set their own requirements. You will likely need good to excellent personal credit — a FICO score of 670+ — and solid annual revenue. Time in business matters as well. While some 7(a) loans are open to startups, most loans go to businesses at least two years old.
Like any loan, you will need to provide documentation. This will include profit and loss statements, business tax returns, personal financial information and a business plan.
How well you meet these requirements will influence your interest rate. The SBA sets its rates to the Prime rate plus 2.25 percent to 4.75 percent. This can be variable or fixed based on your loan amount and lender, but generally, it will be more competitive than the average rates for business loans.
SBA 7(a) loan pros and cons
Because 7(a) loans are designed for working capital, they are best for inventory or other daily expenses but may cost more than a 504 loan.
Pros
Competitive rates. SBA 7(a) loans tend to have lower rates than other business loans on the market, especially if you look at online lenders rather than national banks.
Flexible working capital. 7(a) loans are designed to cover your business’s needs as it grows. This makes them ideal for financing inventory, more workers or any other legitimate expense.
Finance equipment as well. Your business can finance equipment with a 7(a) loan just like it can with a 504 loan.
Cons
Multiple fees. Depending on the size of your loan, you may have to cover a guarantee fee and a down payment in addition to any fees your lender or loan broker charges.
May require a large down payment. Your business could be on the hook for a down payment of up to 30 percent of the total amount your business borrows.
Collateral may be required. Your business may also be responsible for providing collateral to back your loan.
What is an SBA 504 loan?
SBA 504 loans are designed to cover equipment costs and commercial real estate. Much like 7(a) loans, the application process can take months to complete. There is also a required down payment of 20 percent to 30 percent of the loan amount — but for the 2023 fiscal year, there is no guarantee fee.
The eligibility criteria is also similar to 7(a) loans. However, it may be easier to qualify depending on the size of your business and the type of equipment you are financing. And 504 loans tend to be significantly larger. As of June 2023, the average loan size was over $1 million versus the 7(a) average of $475,584.
504 loans are offered through Certified Development Companies (CDCs). A CDC will partner with the SBA to fund a 504 loan of up to $5.5 million per project and up to $16.5 million spread across three projects.
SBA 504 loan requirements
The 504 program has similar eligibility requirements as the 7(a) program, though your net worth and income also play a role in whether or not your business qualifies.
For-profit business based in the U.S.
Net worth less than $15 million
Two years with an average net income of less than $5 million after federal income taxes
Reasonable owner-invested equity
Exhausted other financing options and personal assets
Considered a small business based on SBA size standards
Your loan will be secured by the equipment or property your business purchases, and the documentation your business needs to provide will be the same as with a 7(a) loan.
The interest rates on a 504 loan are fixed, but the SBA is not explicit about the range. If you are considering a 504 loan, reach out to the CDC you would like to work with for information on potential costs and other fees.
SBA 504 loan pros and cons
504 loans are more difficult to qualify for than a 7(a) loan, but fewer fees are involved — at least for the 2023 fiscal year.
Pros
No guarantee fee. The SBA does not charge a guarantee fee on its 504 loans. However, other fees may still apply.
Large loan amount. Your business may be eligible for loans up to $5.5 million per project and up to $16.5 million over three projects.
Long terms. 504 loans can have terms of up to 25 years, depending on the amount you finance and how you plan on using your loan funds.
Cons
Limited uses. Unlike a 7(a) loan, a 504 loan can only be used to finance equipment or commercial real estate.
Longer application process. There is more involved in qualifying for a 504 loan, and your business will need to complete a longer application process than with the 7(a) loan program.
Must apply through a CDC. 504 loans are only available through a CDC. 7(a) loans, on the other hand, are available through banks and alternative lenders.
SBA 7(a) vs. SBA 504: Which is better?
Neither option is better than the other. 7(a) loans are designed for working capital, while 504 loans are designed for equipment and real estate. While SBA loan rates and the amount you can borrow differ, your business’s needs will determine which program is more appropriate.
Loan amount | Interest rate | Description | Fees | |
|---|---|---|---|---|
SBA 7(a) | $5 million | Base rate plus 2.25% to 4.75% | Working capital loans for everyday business expenses | Guarantee fee of up to 3.75% of the guaranteed portion of loan |
SBA 504 | $5.5 million | Base rate plus a set percentage | Financing for equipment or commercial real estate | No guarantee fee for the 2023 fiscal year; CDC processing fees |
When to choose an SBA 7(a) loan
Your business has gaps in cash flow
You need to buy inventory to meet customer demands or grow your business
You need to finance equipment or commercial real estate
You are able to afford the guarantee fee for larger loan amounts
When to choose an SBA 504 loan
You are looking to finance or improve a piece of commercial real estate
You need to finance machinery or other expensive equipment
You want to work with a CDC and can meet job creation or retention goals
You prefer a longer loan term of 10 to 25 years
Alternatives to SBA loans
SBA loans can be difficult to qualify for — and you need to explore other financing options before applying. Common alternatives include bank loans and business credit cards, though there are various options to choose from.
Bank loans. Banks and credit unions offer term loans and lines of credit to established businesses. Many have favorable terms and similar rates to SBA loans.
Alternative loans. Alternative or online lenders also offer term loans and lines of credit. These may be easier to qualify for if you have a newer business or a lower personal credit score.
Credit cards. Business credit cards are a flexible way of funding everyday business expenses. While they often have higher rates than lines of credit, you may be able to take advantage of rewards programs similar to personal credit cards.
Grants. There are business grants available for minority- and woman-owned businesses, as well as grants based on industry. But much like SBA loans, these tend to be competitive.
Equipment loans. If you are considering a 504 loan, you can explore equipment loans for your business. These are secured loans, which means your business may still qualify for low rates.
The bottom line
The SBA’s loan programs are competitive because they are a solid, comprehensive way to fund your business. Whether you get a 504 loan or a 7(a) loan will depend on your business’s financing needs. Either way, you will need to meet strict eligibility criteria and submit a lengthy application for a chance to qualify for one of these competitive loans.
Frequently asked questions
What’s the difference between an SBA 7(a) and 504 loan?
504 loans are meant specifically for equipment financing or commercial real estate. 7(a) can also be used for equipment and real estate but may also be used for any working capital expense.
How hard is it to get approved for a SBA 7(a) loan?
It can be difficult to be approved for an SBA 7(a) loan because of the strict eligibility criteria. Very few businesses are able to be approved each year.
How are SBA 504 rates determined?
Like 7(a) loans, SBA 504 rates are based on the Prime rate plus a set percentage. The rate typically totals about 3 percent of the debt.
