What the SBA 504 Pre-Pay Penalties Actually Mean

Prospective borrowers are often confused by the SBA 504 loan prepayment penalties, beginning with why the U.S. government would implement the penalty at all. Every 504 loan created requires joint efforts from a lender, a Certified Development Corporation, and the SBA. According to 504 guidelines, the lender provides as much as 50 percent of funding, the SBA/Community Business Finance as much as 40 percent of the loan, and the borrower contribution may be as low as 10 percent.

To fund each loan, Community Business Financing must sell a 10-year or 20-year federally insured bond (debenture) to private investors. These private investors are guaranteed a return on their investment throughout the duration of the bond. If the borrower pays off the loan early, additional funds need to be added to compensate for the remaining life of the bond after it no longer generates interest income. The borrower’s pre-penalty payment is designed to cover this lost interest income.

Prepayment Penalty Is Contingent on Loan's Debenture Rate

Many assume that the prepayment penalty on their SBA loan would actually be higher than what they’d pay on a conventional loan. However, this is not always the case. The SBA 504 prepayment penalty is contingent on the loan’s debenture rate, which directly impacts the penalty rate.

Still, looming concerns and misconceptions over 504 prepayment penalties can have negative consequences for business owners seeking funding. Some entrepreneurs believe that the penalties associated with 504 funding make the loan not worth pursuing. Additionally, many entrepreneurs who do have a 504 loan think that they have to wait until year ten before being able to refinance.

Avid Commercial Can Help You Make An Informed Decision About Your SBA 504 Loan

Fortunately, it is possible (and even financially advantageous) to pre-pay an SBA 504 loan. Yes, like many other commercial loans, SBA funding will incur a fee for paying off the bond before maturity. However, sometimes, this penalty is manageable. At Avid Commercial, our team of finance specialists reviews the penalties invoked with early payment. We can run a breakeven analysis to determine over what period of time it would take to justify paying the loan off at a higher rate, while still paying the penalty. More often than not, we find that we can make it work mathematically, even with the prepayment penalty included, to help our clients protect the financial health of their business.

Want to hear more about refinancing your SBA 504 loan? Contact Avid Commercial today to schedule a consultation with one of our professional financial advisors.

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