The 7(a) Loan Guaranty
Named after the part of the Small Business Act which allows the Agency to facilitate modest loans for Small Businesses in the U.S., 7(a) loans are usually the most straight-forward of the products offered, and are also one of the most popular.
For the purposes of the 7(a) Loan Guaranty, lenders are called participants, as they are taking part in the 7(a) program alongside the SBA. Most U.S. Banks are participants, although there are some exceptions to this. In addition to the Banks, there are also a number of other lending agencies (from the private and non-profit sectors) who are participants. This widens the variety and quantity of lenders which borrowers can take advantage of.
Borrowers can’t access 7(a) program funds unless the money is offered under guaranty. When selecting a lender, in order to be successful in obtaining 7(a) program financing, a borrower can only choose an Institution that follows the SBA rules for appropriate borrowing. The SBA never guarantees 100% of a loan, as both the SBA and the lender must share the borrowing risk. A loan can’t be offered under the (7a) program unless a proportion of the loan to be guaranteed by the SBA.
Ultimately the decision whether to lend or not is down to the participant; the SBA isn’t liable if the participant makes a rash lending decision or the borrower doesn’t tell the truth about their circumstances.
To take advantage of a loan, the borrower can either apply to a participant directly, or through a broker that has access to 7(a) program lending providers. Note that the loan guarantee is offered to the participant, not the borrower. If the borrower defaults, the SBA (Government) will pay out to the participant, to the level of its guaranty.
When a borrower applies for a 7(a) loan, the terms of their borrowing must comply with 7(a) rules and requirements. When a loan has been agreed that complies with the (7a) program regulations, the Government guarantees a part of the borrowed amount and the loan is then part of the 7(a) loan program.
Ultimately it is the lender who decides whether to agree the loan or not, as it is their loan rather than the Government’s. A lender can turn down a loan request, even if it meets the criteria for the SBA’s guarantee. The SBA doesn’t actually lend money; it only acts in a guarantor role. This means that it’s essential that when you approach a participant for loan, you can demonstrate your creditworthiness and meet all their borrowing requirements.
The percentage of the loan amount that the agency will guarantee depends on the value of a 7(a) program loan and its specific type. The Export Working Capital Loan Program loans may have up to 90% of their value guaranteed. In comparison, the Agency will only guarantee up to 50% of an SBA Express loan. As a general rule the Government guarantee up to 75% of the loan total where the value is in excess of $150,000. For loans for smaller amounts, the Agency guarantees up to 85% of the total.
The maximum amount that can be borrowed through a 7(a) loan is $2,000,000. Under the 75% guidance, the Agency’s maximum exposure would therefore be $1,500,000. Note that when it comes to SBA Express loans, 50% is the maximum amount that the agency would guarantee, regardless of the Express loan size.
When participants offer a 7(a) program loan, the amount of interest they can charge on it is controlled by the SBA. Lenders may offer fixed or variable rates of interest.
In the case of a product which has a value of $50,000 or more, has a fixed rate of interest and needs to be paid back in seven years or less, the largest amount of interest which can be charged is the bank’s Prime Rate and up to 2.25%. For loans which will be paid back over more than seven years, the maximum amount of interest will be the bank’s Prime rate and up to 2.75%.
The interest rate is limited to Prime Rate with up to an additional 3.25% (where the loan is scheduled to be paid back in seven years or less) and Prime Rate with up to an additional 3.75% where a loan is scheduled for repayment over seven years or more, when the loan amount is $In comparison, where a loan amount is between $25,000 and $50,000.
For borrowers needing a smaller loan amount, typically less than $25,000, the interest rates are less competitive; for loans scheduled for repayment in seven years or less, interest is typically the bank’s Prime Rate with up to an additional 4.25% added; for loans taking longer than seven years to pay back, interest rates may rise to as much as 4.75% above the bank’s Prime Rate.
The interest charges when a 7(a) program loan has a variable rate of interest are usually calculated in relation to either the Bank’s Prime Rate or, alternatively, the SBA peg rate. The latter rate is decided on by taking an average of the rates of interest usually agreed when the federal government finances a loan which is similar (for example taken out over the same number of years) to the 7(a) program loan product.
Interested parties can find the current SBA peg rate (it’s recalculated each quarter) in the “Federal Register”. The rate of interest varies depending on individual and corporate variables. In each case the participant will offer a loan at a particular rate of interest and the borrower can choose to go ahead, refuse or try to renegotiate the interest rate.
As the interest rate is likely to alter during the course of the repayment process, the lending institution will agree the borrower how often the rate of interest will alter. This time period may be every month, quarterly, annually or some other pre-agreed schedule.
The Agency makes money from every loan that it guarantees, as lenders pay money across for the privilege of a guarantee and also as a service charge. This helps to keep the Agency’s guarantor role cost neutral. Fees are operated on a sliding scale: the greater the amount guaranteed, the larger the fee charged by the Agency will be. In some cases the participant will pass on the cost of the guarantee fees to the borrower, typically after the loan has been taken out. Participants are not allowed to recoup the service charge they pay the Agency from the borrower.
For small loans (less than $150,000) up to 25% of the guarantee loan fee can be held on to by the participant.
||Percentage guarantee fee
|> $150,000, less than or equal to $700 000
||An extra 0.25% on the proportion of the loan which is over $1,000,000. The first $1,000,000 will attract an interest rate of 3.5%. Money in addition to the first $1,000,000 will attract a rate of 3.75%.
The charges for servicing the loans are set by the Agency at 0.545% of the part of the loan which is under Agency guarantee. This relates to any loans which obtained approval on, or subsequent to 1st October 2005.
One of the advantages of a 7(a) program loan is that the participant is not allowed to charge the borrower any additional fees, including, but not limited to:
- Bonus points
- Origination fees
- Application fees
- Money for brokerage
There is one exception to this rule: applicants to the Export Working Capital Loan Program may be required to pay a commitment charge.
The SBA has a number of requirements that borrowers must meet before they can apply for a 7(a) program loan. If an owner owns greater than or equal to 20%, they are required to guarantee their SBA loan!
Typical requirements for an SBA loan include:
- Proven ability to repay the loan amount
- Trustworthy and honest
- Amount of equity provided
- Business management skill
A wide diversity of businesses are able to access 7(a) program loan funding, as the parameters have deliberately been made as broad as possible. Typically, a suitable business for a loan will fall within the Agency’s size requirements, be able to show that they can’t fund their business requirements from existing resources, are set up to make a profit and have the capacity to pay the loan back.