Does My Loan Have an SBA Prepayment Penalty?

The U.S. Small Business Administration (SBA) has helped millions of business owners gain access to affordable business loans. These programs offer a tremendous range of benefits for borrowers, but some may also include an SBA prepayment penalty fee that you should know about before you choose your loan.

What is the SBA prepayment penalty and when would it impact you? Here’s everything you need to know before you close your loan.

What is the SBA prepayment penalty?

A prepayment penalty is a fee that’s charged if your loan is paid off before the end of its term. While you might go into the loan process planning to use the entire term to pay off the loan, there are circumstances that could lead to an earlier payoff and an SBA prepayment penalty. For example, if you sell the building or business that you acquired with your SBA loan or if you find better loan terms and refinance your loan, you may need to pay a prepayment penalty.

A prepayment penalty must be disclosed by your lender as part of the lending process, so you should be aware of it well before you close. However, it’s still a good idea to understand the circumstances that could trigger a prepayment penalty.

SBA prepayment penalty for the SBA 7(a) loan program

SBA 7(a) loans are the most popular SBA loan option because they offer borrowers excellent terms on loans up to $5 million, flexible uses, and competitive rates. Terms range from 10 to 25 years and the length of your term will determine if you have a prepayment penalty.

For SBA 7(a) loans with a term of less than 15 years, there’s no prepayment penalty.

For SBA 7(a) loan has a term of 15 years or more, you may have an SBA prepayment penalty. Prepayment penalties apply when you voluntarily prepay 25% or more of the outstanding balance within the first three years after the date of your first disbursement. The prepayment penalty is:

  • 5% of the amount of the prepayment in the first year after disbursement
  • 3% in year 2
  • 1% in year 3

After the three-year period since your first loan disbursement, the prepayment-penalty period is over.

If your SBA 7(a) loan has a prepayment penalty, you may be allowed to make partial prepayments without incurring a penalty. This includes additional payments toward the outstanding principal that are less than 25% of the outstanding balance within the prepayment penalty period.

SBA prepayment penalty for the SBA 504 loan program

SBA 504 loans are an excellent option for commercial real estate-related financing. The terms are very beneficial for purchasing or renovating an existing property, undertaking ground-up construction, or refinancing an existing business loan, among other uses. It offers a low down payment (typically just 10-15%,), a fixed interest rate over the life of the loan, and longer repayment terms that make it easier to budget and repay your loan.

However, all SBA 504 loans include a prepayment penalty. For SBA 504 loans with a 20- or 25-year maturity, there is a 10-year, declining prepayment penalty. This is calculated based on the loan amount and the debenture rate (which is your interest rate on your 504 loan). Here’s how it works and an example:

  • The maximum prepayment penalty in the first year is the full interest on the remaining principal for the SBA 504 loan. So if your SBA 504 loan funded in May 2023 when the interest rate was 4.67%, your maximum prepayment penalty is 4.67% of the outstanding balance on your loan.
  • For each year after that, the maximum prepayment penalty declines by 10%. So, in year 2, it would be 90% of the interest on the remaining principal for the SBA 504 loan. Using the example above, your prepayment penalty in the second year would be calculated by finding 4.67% of your remaining balance, then determining 90% of that amount.
  • The penalty rate declines by 10% each year until, by year 11, there is no longer a prepayment penalty.

For SBA 504 loans with a 10-year term, the penalty declines over five years instead. The penalty declines by 20% each year until, by year 6, there is no prepayment penalty.

The lender that’s funding the first mortgage in an SBA 504 project has control over the prepayment penalty on that loan. Be sure to talk with your lender to get all the details. 

Paying off your SBA 504 loan

Unlike other loans, you can’t make partial prepayments for an SBA 504 loan. if you want to prepay, it must be paid in full.

If you’re selling the commercial property that you purchased with an SBA 504 loan, you may be able to arrange for the buyer to assume the SBA 504 loan. In that case you might not be charged with a prepayment penalty.

Consider SBA prepayment penalty terms when choosing your best loan option

If you’re considering an SBA 7(a) or SBA 504 loan, talk to your loan officer and your accountant or financial manager about how a prepayment penalty could impact your business. In some cases, the benefits will outweigh the prepayment penalty. In others, it may be in your best interest to pay the loan as agreed until the prepayment-penalty timeframe has passed.

Pursuit helps you get the financing and information you need for success

It’s important to know about SBA prepayment penalty fees and other details about small business loans to make the best decision for your business – and Pursuit can help at every step. For more than 65 years, we’ve helped small business owners in New York, New Jersey, Connecticut, and Pennsylvania get the financing needed to reach higher and grow. Whether you’re exploring business loan options or just want to learn more, contact us today.

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