Banks and other traditional commercial lenders offer affordable interest rates, but they are reluctant to lend to small businesses because they’re risky investments. Only about half of small businesses survive their first five years. And if the business goes under before the owner has finished repaying the loan, it’s unlikely the lender will get their money back.
To protect themselves from this situation, lenders prefer lending only to the most qualified, established businesses. The SBA expands access to affordable financing to more business owners by offering a government loan guarantee—of up to 85% of the loan size—on the loan. If you default on the loan, it’s on the SBA to fulfill their guarantee—and pay back the lender.
Since the SBA absorbs the risk of default, lenders can work with riskier borrowers who otherwise wouldn’t have had access to the capital. The SBA works with a host of partner banks and lenders to get funds into the hands of small business owners.
(P.S. If you don’t have time to take a deep-dive into these government small business loans, get moving with the SBA Loan Application Checklist below.)
How to Qualify for Government Business Loans
Government business loans are an excellent option for small business owners, but not everyone can obtain one. When borrowers default on their SBA loans, the SBA (because of the guarantee they provide) pays back the lender. This money comes from fees that borrowers pay at the outset, as well as from taxpayer dollars.
To reduce the cost to US taxpayers, the SBA and banks set strict qualification requirements for SBA funding.
In general, you must meet the following requirements to qualify for a government business loan:
- Strong personal credit score (over 680 preferable)
- You must have invested your personal time and money in the business
- You must have tried, unsuccessfully, to obtain other financing options (e.g. a local bank turned you down for a regular loan).
- Business is profitable
- Business is over 2 years old
SBA microloans, which we’ll discuss in a minute, have slightly easier requirements, but the one thing that doesn’t change across the different programs is strong personal credit. That’s a prerequisite to getting almost any type of government loan.
Next up, we’ll provide specific details about each kind of government business loan.
Government Business Loans: The Most Common Types
There is no “one” government loan for business that the SBA guarantees. There are several SBA loan programs, varying primarily in terms of the loan size and what you can use the loan for.
SBA 7(a) loans, 504/CDC loans, and microloans are the three main loan programs for small businesses.
The 7(a) Loan Program
The 7(a) Loan program is the most popular SBA program that provides government loans for small businesses.
A 7(a) loan is a term loan that can fit a wide variety of financing purposes. Many business owners use 7(a) loans as general working capital loans. The bank will lend you a lump sum of money, which you’ll pay back (plus interest) over a fixed repayment period.
With a 7(a) loan, business owners can borrow up to $5 million in capital. But the average loan size was $407,616 in 2017.
The SBA sets maximum interest rates on SBA 7(a) loans and assesses some fees. The SBA usually levies these fees on the lender, but the lender passes them on to the borrower.
Both the interest rate and fee depend on your loan’s maturity and the size of the loan.
- Loans under $150,000: No fees
- Loans $150,000 and up (for a maturity of one year or less): 0.25% of guaranteed amount
- $150,000 to $700,000 (for maturity of more than one year): 3% of guaranteed amount
- $700,000 and up: 3.5% of guaranteed amount plus an additional 0.25% on guaranteed amounts over $1 million
You and the lender who provides your 7(a) loan will negotiate an interest rate, but it’s subject to maximums set by the SBA. Interest rates may be either fixed or variable, but the maximums are tied to the prime rate.
Your interest rate cannot exceed the following:
- Loans under 7 years maturity: No higher than Prime rate + 2.25%
- Loans over 7 years maturity: No higher than Prime rate + 2.75%
- Rates are higher on loans under $50,000 and expedited loans.
To see what your APR could be on a 7(a) SBA loan, use this free SBA loan calculator.
The 7(a) Loan Program offers small business owners flexible and multi-purpose government small business loans. Use these loans for working capital, refinancing existing debt (in some circumstances), purchasing equipment or real estate, as a business construction loan, and more.
This federal business loan is best if you have general business financing needs and need a large loan to fulfill that need.
Business owners in a more specialized situation, however, might want to check out some of the SBA’s more specific programs.
The CDC/504 Loan Program
The CDC/504 Loan Program offers specialized small business government loans for business owners who want to purchase or upgrade commercial facilities. You can use these to buy or renovate commercial real estate, warehouses, manufacturing facilities, equipment, heavy machinery, and other capital intensive assets.
CDC/504 loans involve three different parties:
- A Certified Development Company (CDC): CDCs are non-profit, SBA-approved community lenders who support economic development and business development within the community. The CDC lends and guarantees 40% of the loan.
- The bank: The bank lends 50% of the loan.
- The borrower: The borrower put downs the remaining 10% as a down payment. For startups and certain types of projects, the borrower might have to put up a larger down payment.
These loans go all the way up to $13 million+ in funding depending on your industry type and how many jobs you’ll help create along the way (or other public policies your project will benefit).
Government small business loans from the CDC/504 program are subject to processing fees and origination fees, amounting to about 3% of the loan amount. Sometimes, you can roll the fee into the loan.
As for interest rates, the CDC and bank can charge different rates on each portion of the loan. The bank loan interest rates are negotiated between the bank and the borrower. The rates on the CDC portion of the loan are tied to the 5-year and 10-year Treasury notes. Currently, the rates are around 5% on the CDC portion.
The CDC portion of the loan is fixed-rate, but the bank might charge a variable interest rate on the bank portion of the loan. Generally, interest rates are low even on the bank portion because the property serves as valuable collateral for the loan.
These government business loans are a great option for businesses looking to buy or upgrade commercial real estate, equipment, machinery, or other capital intensive assets. 7(a) loans can also be used for these purposes, but you’ll save a significant amount of money if you opt for a 504 loan for major asset purchases and upgrades.
One caveat is that these small business government loans can really take a long time to qualify for and fund. This is mostly due to the fact that local CDCs only accept a certain number of 504 loan applications, and the underwriting process through the CDC takes a fair amount of time. For instance, you’ll need to have a professional appraisal on the property before the loan closes.