A blog post

Getting the Right SBA Amount Down and understanding the required down payments.

Posted on the 29 July, 2013 at 4:15 pm Written by in Business, Loans

As simple as it may sound, the ex- act required down payment for a U.S. Small Business Administration (SBA) loan is often a source of confusion for commercial mortgage brokers, borrowers and lenders alike. The reasons vary, but many industry professionals have long relied on hearsay when it comes to the required amount of down payment for SBA requests. Commercial mortgage brokers must keep themselves informed about the guidance provided by the SBA regarding the required down payment for each of its programs — the SBA 7(a) and SBA 504, in particular — as well as relevant industry practices.

A frequent source of confusion stems from the SBA 7(a) program’s requirements regarding borrower down payment versus lenders’ requirements. Although SBA has oversight on credit and eligibility decisions on 7(a) loan requests, lenders often have their own credit criteria geared toward SBA lending. As a result, lenders may decline a loan request for any number of reasons that may not necessarily be related to SBA requirements.

SBA 7(a)

When it comes to the required borrower down payment on 7(a) loans, it is beneficial to know what SBA exactly mandates. According to a document titled “Lender and Development Company Loan Programs” published by the SBA in 2009, “The lender must determine if the equity and the pro forma debt-to-worth are acceptable based on the factors related to that type of business, experience of the management and the level of competition in the market area.”

“The lender must include in its credit analysis a detailed discussion of the required equity and its adequacy,” it adds.

With this in mind, it is clear that lenders rather than the SBA are usually the actual decision makers on the amount of required equity. The SBA typically will raise questions if the amount seems light given the industry or nature of the transaction, but often lenders’ down payment requirements are what borrowers have to meet.

Many lenders typically will require a 10 percent down payment on the purchase of fixed assets. They also will ask for more than 10 percent to be injected if the request is made by a startup or for business acquisition, which reflects prudent lending standards because the risk profile of these requests is higher, meaning that more equity is required to mitigate that risk.

Closing costs

Commercial mortgage brokers also should advise their clients about the possibility of rolling the closing costs into the total loan amount, which may not be the case with conventional loans. For example, if a property is purchased at $1 million and the closing costs are $30,000, many lenders will allow these costs to be financed along with the purchase price. In this case, if a borrower provides a 10 percent down payment on a fixed-asset purchase of $1 million, the loan amount will be $930,000 and the total out-of-pocket equity down payment from the borrower will be $100,000.

In addition, remember that lenders typically consider the totality of the request (credit scores, historical repayment ability, collateral, management experience, etc.) in determining their comfort level with the down payment amount that borrowers are required to inject. As a result, lenders’ decisions can vary and a decline by one lender does not mean necessarily that the request is not suitable for SBA approval. Similarly, lenders may vary in their down payment requirements.

SBA 504

The SBA 504 program is more direct regarding required down payments. This program typically provides as much as 90 percent funding — a conventional first mortgage equaling 50 percent of the total project, and a below-market, 10-year or 20-year fixed-rate second mortgage for as much as 40 percent of the project provided by an SBA certified development company (CDC). The borrowers’ down payment will be about 10 percent to 20 percent.

In the 504 program, which can be used only to purchase fixed assets such as commercial real estate or equipment, the SBA requires that borrowers inject 10 percent as a down payment on the total project inclusive of closing and soft costs. If the business is a startup, an additional 5 percent is required, increasing the down payment to a minimum of 15 percent. If the business is for the purchase of a special-use facility (ice-hockey rink, hotel, car wash, etc.), an additional 5 percent also  is required.

When an additional 5 percent equity down payment is required, the amount typically reduces the second mortgage. For example, if the loan request is for a $1 million startup car wash, the bank makes a 50 percent first mortgage, SBA funding provides a 30 percent second mortgage and the borrower injects $200,000 as a down payment.

The SBA provides CDCs with some latitude in determining whether a business is considered a startup. Many CDCs will consider the business a startup only if it has been operating for two years or less, however. Finally, commercial mortgage brokers should know that payments made upfront by borrowers toward soft and closing costs — if documented — can be counted toward equity requirements if these were explicitly used for the project being submitted to the SBA.

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Commercial mortgage brokers should look for new ways to help their clients and clarify the areas in the loan process that can be sources of confusion. Kruse and Crawford can provide advice on down payment requirements and assist in determining the right loan source for your business funding.

As published in Scotsman Guide’s Commercial Edition, July 2013. By Jim Noone

Jim Noone is vice president at Prudent Lenders. Prudent Lenders provides U.S. Small Business Administration 7(a) loan processing, closing and portfolio servicing to community banks across the country with speed and efficiency and the added peace of mind that it has been “done right.” http://prudentlenders.com/  Reach Jim Noone at (610) 768-7792 and jnoone@prudentlenders.com.