To SBA or Not To SBA?: For Larger Loan Amounts, Not!
It's the general opinion among the multi-unit franchise owners I speak with that the credit crunch is easing, even as interest rates are rising. If you have a proven track record of creating and sustaining profits with your units and can demonstrate that in a professional loan proposal to your friendly bank, it is highly likely you will get the money you seek. So assuming all that, here's a question for you: What kind of money should you get?
There is a commonly held idea that SBA-guaranteed loans are the best way to go. And on the surface they look appealing. However, if you are a successful multi-unit operator, it's highly likely you're going to be looking for financing in the range of $1 million to $3 million. When you're looking for loans in that amount, it's important to take a second look at the fee structure and current interest rates.
When you add on the 3.5% fee that comes with a sizable SBA loan, sometimes that can make a difference in whether or not that loan is the best choice for you. Let's take look at some numbers.
Technically, the SBA charges the SBA loan guarantee fee to your friendly bank, but your banker is allowed to (quite happily) pass this fee on to you, the borrower. You then get to repay the fee with the funds from your loan, which means adding it to the total amount of the loan and/or part of the monthly payment.
The amount of the fee depends on the size of the loan. The SBA guarantees 75% of loans in excess of $150,000; then, for amounts up to $700,000, it charges a 3% fee on the portion of the loan they are guaranteeing. For amounts greater than $700,000, the fee is 3.5%; and for any guaranteed portion above $1 million, they add on an additional 0.25%. This is for loans with terms longer than 12 months.
Let's assume that you're going to borrow $2 million with loan terms of more than 1 year. The duration of the loan does not affect the loan guarantee fee, so if you're seeking to reduce your monthly payment, perhaps it is in your best interest to extend the loan as far as possible. In this case, the SBA-guaranteed portion of that loan (75%) is $1.5 million. The SBA loan guarantee fee is going to be 3.5% on the guaranteed portion, or $52,500.
They're going to add an additional guarantee fee of 0.25% on the remaining $500,000, which comes to $1,250. So you get to pay a loan guarantee fee of $53,750 for the pleasure of borrowing $1.5 million that's guaranteed by the SBA.
Now let's take a look at current interest rates. As of this writing, the prime rate is 5%. Here are the interest rates on SBA 7(a) loans for August 2018:
9.25% (5% + 4.25% markup)
$25,000 – $50,000
8.25% (5% + 3.25% markup)
7.25% (5% + 2.25% markup)
So on the $2 million loan, if you can borrow at prime plus 2.25% with your bank and you are creditworthy enough to not need the SBA loan guarantee, you just saved yourself $53,750. You're welcome!
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