To launch and grow with strength, you’ll eventually need to secure financing for your small business. While this can come from a range of sources, one of the best options is the SBA 7(a) loan. This loan offers tremendous benefits for you, making it one of the most popular among the U.S. Small Business Administration (SBA) financing options.
In this overview, you’ll learn what the interest-only loan period is for SBA 7(a) loans, how it helps your business, and how to work with your lender to determine if this is the right strategy for you to take as you explore and apply for small business financing.
What is the SBA 7(a) interest-only loan period?
When you receive funding through the SBA 7(a) loan program, you might use the loan proceeds to pay for a range of expenses. This can include building construction and renovations, furniture, fixtures and equipment (FF&E), new inventory purchases, fill staffing needs, and support marketing efforts.
In cases like this, there’s often a period of time where you receive the initial financing to get renovations going, but your business can’t be operational until those renovations are complete.
The SBA and its partnering lenders recognize the financial challenges that can result from complex financing situations like this.
The SBA 7(a) loan program can include an interest-only period to provide a financial cushion to support your business during this process. In this transitional period, rather than making full principal-and-interest payments, you’ll make interest-only payments. The only interest paid is on the amounts already dispersed.
Depending on the specifics of your project and total financing amount, this can save you hundreds or even thousands of dollars each month during the interest-only period. This eases your financial stress and is especially important for new businesses or when projects include construction.
An example of the interest-only loan period
The interest-only period reduces your monthly payment due while business operations are on hold. The interest is paid only on the funds that have been distributed to you. Here’s an example:
Let’s say your business is a new bakery. You need $100,000 in financing, which includes the renovation of a space that was previously a café. That renovation is projected to cost $50,000 and take three months in total. Then, it will take you about two months to get your team hired and trained and to get sales fully underway. Working with your SBA-approved lender, you apply for an SBA 7(a) loan for $100,000, with an interest-only loan period included:
- At closing, $50,000 is given to your contractors for the renovations to the space. Over the first few months during renovation, your loan repayment will only be the interest accrued on the $50,000 that has been released. This can save you hundreds of dollars (or more) during this critical period when you’re preparing to launch but the business isn’t operational yet.
- Let’s say that in the following month, as renovations are completed, another $25,000 is distributed to pay for furniture, fixtures, and equipment to outfit your commercial kitchen and the front of the house. Then, your repayment amount will be interest-only for the $75,000 in total that’s been dispersed.
- Soon after, the final $25,000 is paid to you so that you can hire employees, purchase ingredients and inventory, market your new bakery, and get things up and running. Your loan will likely include another couple of months of interest-only payments after you’ve moved in to give you and your team some time to get your bakery fully operational.
- With your business successfully launched and day-to-day operations underway – around the six-month mark – your loan payment changes to include the full monthly principal-and-interest payment, as agreed to in your loan terms.
Why would your loan include an interest-only period?
There are two key circumstances where you or your lender may suggest that an interest-only period be included with an SBA 7(a) loan:
- When your project includes the construction or renovation of a property and your business will have a significant delay before it can be operational, along with potentially high costs during that time. As a result, there would be financial stress for you and your business.
On the other hand, a straightforward loan for inventory and working capital, likely wouldn’t be a candidate for an interest-only period because your business wouldn’t experience any delays. - If you have a start-up business in the early stages, you would likely need several months before the business is established enough to have sufficient cash flow. In this case, you might also be offered an interest-only period to build up operations to cover a full principal-and-interest loan repayment.
How you and your lender will work together to determine interest-only payment benefits
During the loan process, you and your lender will work together to determine whether an interest-only period is necessary, and how long that period will be. Generally speaking, you’ll consider:
- Timing: This includes both how long it will take before your business is fully up and running, and ready for full payments, as well as how long an interest-only period should last. For example, if your contractor estimates that renovations will take three to four months and your lender agrees to another couple of months for ramp-up, then you may receive a six-month interest-only period.
- Reasoning: Understanding why your business may need an interest-only period helps a lender structure the SBA 7(a) loan appropriately. The more your lender knows about your project, the better positioned they’ll be to help you, especially if you think that you’ll need a longer interest-only period. Once your interest-only period is complete, the following month your loan will start to amortize over a set number of months and your payment will include both principal and interest.
What else should you know about interest-only periods?
Communication is key throughout the loan process, so be upfront with your lender about your business’s needs and any anticipated challenges. Here are some common situations:
- If your business doesn’t have any income yet, you can ask your lender to include an interest reserve in the loan. Your lender will estimate monthly interest payments for the interest-only period and include a reserve within the total loan that you can draw from to make payments during the interest-only period.
If you have an existing business that’s expanding its operations, your lender may not agree to the interest reserve if your current revenues can support the interest-only payment. - If your business becomes fully operational and cash-flow positive before the interest-only period ends, you can ask your lender if they’ll re-amortize the loan. This will come with modifications and potential small fees, but it can help you start paying down the principal.
- If your business isn’t ready to make full payments at the end of the interest-only period, an extension may be made if your lender agrees that your situation would warrant that. If so, then your lender may agree to extend the interest-only period, but you could have a loan-modification fee.
This situation can usually be avoided if you and your lender have worked together to thoroughly understand your project and financing needs during the application process.
Pursuit supports success at every stage
Every day, Pursuit helps business owners navigate the SBA 7(a) loan process – and a range of other business loans and a line of credit – to help you secure the financing needed to launch and grow. As part of the application process, we can help you understand whether an interest-only loan period would be useful for your business, and we’ll work through all your questions about the SBA 7(a) loan and other options together.
Contact us to learn more about how we can help your business grow.
