sba loan prepayment penalty

SBA Loan Prepayment Penalty: A Guide for Business Owners

February 10, 2024

The Small Business Administration (SBA) of the United States has assisted millions of entrepreneurs in obtaining low-interest company loans. These programs provide a wide range of incentives for borrowers. However, some may also have an SBA prepayment penalty cost, which you should know before selecting a loan.

What is the SBA prepayment penalty, and when will it affect you? Here's everything you should know before closing your loan.

Understanding SBA Loan Prepayment Penalty

Some lenders charge a prepayment penalty for repaying your loan ahead of time. While prepayment penalties are common with mortgages and vehicle loans, several business loans also charge similar costs.

Lenders often determine the prepayment charge as a percentage of the loan's payback amount. Your final company loan agreement should include all related expenses for repaying your loan early.

Spending off debt early might save you money, but you may spend hundreds or thousands in prepayment fees.

SBA 7(a): Loan Program Prepayment Penalty

Prepayment costs for SBA 7(a) loans apply only when a borrower "voluntarily prepays 25% or more" of the loan's outstanding balance during a 15-year period. The borrower must repay the loan within three years of the first loan payout. So, unlike many other types of loans, if a borrower decides to make a prepayment more than three years after receiving cash, there will be no interest charges. In addition, the borrower is only charged for the prepayment amount, not the total loan amount. It's also worth noting that if your loan is for less than 15 years, your lender cannot charge prepayment costs.

The prepayment penalty for SBA 7(a) loans is as follows:

  • Year 1: 5% of the entire prepayment amount.

  • Year 2: 3% of the entire prepayment amount.

  • Year 3: 1% of the entire prepayment amount.

SBA 504 Loan Program Prepayment Penalty

The prepayment penalty for SBA 504 loans lasts 10 years. The SBA 504 loan prepayment penalty lasts for 10 years to deter borrowers from paying off the loan too fast. This allows investors with an interest in the loan to continue earning projected revenue.

The SBA 504 loan program consists of 2 loans: a first mortgage from a bank or SBA lender and a second mortgage from a Certified Development Company (CDC). It is an ideal loan for businesses searching for a long-term property solution since it provides at least 25 years of financing; nevertheless, due to the duration of the prepayment penalty, company owners must consider their choices.

The 7a loan is also available with a 25-year duration and amortization, with just a 3-year prepayment penalty.

The first mortgage may or may not include a prepayment penalty, depending on the bank or lender and the transaction. However, the second mortgage always has a 10-year prepayment penalty. However, it's not as bad as it sounds.

Comparing SBA loan options

When looking for a small company loan, there are various options available, with many comparing SBA 504 versus 7a. If you want to buy commercial real estate or heavy machinery or equipment, an SBA 504 loan is usually the most suitable option. If you want to buy a business or receive working capital, an SBA 7A loan may be better.

Business owners can use an SBA 504 loan to purchase a structure, fund new construction or building modifications, or acquire heavy machinery and equipment. An SBA 7a loan can provide short-term or long-term operating capital, purchase an existing firm, refinance current business debt, or buy furniture, fixtures, and supplies.

 SBA 504 LoanSBA 7(a) Loan
 Loan size
  • Maximum: $20 million 

  • 5.5 million on each

  • Maximum: $5 million
 Interest rate
  • Fixed
  • Predominantly variable; some fixed-rate options
 Terms
  • 25 years – real estate

  • 20 years – real estate

  • 10 years – equipment

  • Up to 25 years – real estate

  • Up to 10 years – business acquisition, equipment

  • 5 to 7 years – working capital 

  • Weighted average for mixed-use requests

 Down Payment 
  • 10% Borrower
  • Minimum 10% borrower (often 20-30%)

Other Business Loans with Prepayment Penalty

Many types of loans may have a prepayment penalty. As a result, if you're thinking about getting a business loan, you should ask your lender if there is a prepayment charge. However, you should pay close attention to the following loans, which carry a prepayment penalty:

Personal loans for businesses.

If you are thinking about getting a personal loan for your business, keep an eye out for the prepayment penalty. Some mortgage lenders will charge you a penalty if you pay off your loan early. If feasible, use personal loans without prepayment penalties.

SBA loans

The prepayment penalty applies to SBA 7(a) loans with a 15-year or longer term for the first 3 years. Other SBA loans may also have prepayment penalties in varying forms. The prepayment penalty on SBA 504 loans, for example, might last up to 10 years.

Business auto loans

Prepayment fees are common on vehicle loans for consumers and businesses. If you're financing a car for your business, make sure you know this.

Commercial real estate loans

Prepayment costs on commercial real estate loans are very high. In reality, if you wish to avoid a penalty for prepaying a commercial real estate loan, you may need to hire attorneys to establish a defeasance account. This is a time-consuming and costly procedure that needs financial professionals. All of this implies that you should try to avoid prepaying for a commercial real estate loan. When assessing your alternatives, ask your mortgage provider if they charge a prepayment penalty. If they impose these costs, you might want to reconsider the offer.

Calculating prepayment penalty

To calculate the prepayment penalty, first determine which kind of penalty applies to your loan. Prepayment fines can take several forms, including:

  • A proportion of the outstanding principal.

  • A certain amount of interest is paid over a specific time period.

An interest point difference between your interest rate and current market rates, multiplied by the outstanding principal.

Assume you still owe $150,000 on your mortgage and have a 5% interest rate. Here are the steps for calculating the prepayment penalty:

Find interest-only payments for 6 months. First, divide the interest rate in half to obtain 2.5 percent. Multiply this figure by the outstanding debt to get interest paid in six months. $3,750 would be the result of multiplying $150,000 by 0.025.

Please remember that these are broad stages, and the exact computation depends on your loan arrangement conditions. It is always advisable to study your home loan contract and speak with your lender. This will enable you to determine the prepayment penalty applicable to your loan.

Finding Business Loans Without Prepayment penalty

If you're seeking a business loan, you should ask the lender directly about the prepayment penalty. If you are further along in the process, thoroughly review loan agreements before signing them.

It is feasible to avoid prepayment costs by using an online or alternative lender, especially if you are seeking a short-term or rapid business loan. However, it is advisable to evaluate any additional fees or costs linked to these loans.

Conclusion

Many business owners do not want to pay back their loans; therefore, they avoid discussing prepayment costs. This is a mistake. Even if you don't expect to pay off your loan debt quickly, it's always a wise idea to have choices. While you won't have a choice among loan types, if you do, look for loans with no prepayment penalty. Also, if you want to learn more about loan penalties or costs you might have overlooked, check out our dedicated team.Again, we need to look at the merits of SBA loan programs, especially for small business owners.



Sam Haq, CEO

Commercial Lending USA

www.commerciallendingusa.com

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