Guaranteed Business Loans: The 3 Types Explained
Funding your business and covering company expenses can be costly whether you’re just starting a business or have been operating for many years. If you’re looking for a small business loan, it may seem like there’s no shortage of options when it comes to securing financing. In fact, there are collateral and no-collateral loans, short-term financing, and even merchant cash advances or credit cards to help meet your funding needs.
One option you’ll likely come across is a guaranteed business loan. Guaranteed business loans are quite common and may sound appealing once you understand the details of how they work.
In this guide, we’ll go over what a guaranteed business loan is, the different types, and how to tell if it’s going to be a good fit for your business needs.
What are guaranteed business loans?
When you hear the term ‘guaranteed business loan’, you may assume that means you’re guaranteed to get approved for the loan. Unfortunately, this isn’t the case at all. Borrowers still need to apply and qualify for guaranteed business loans. The “guaranteed” aspect of the loan means that’s it’s backed by either collateral, a deposit or a formal agreement.
This helps ensure that the loan will still be paid in the event that the borrower defaults on the payments. Unlike unsecured business loans, lenders aren’t just relying on higher interest rates to limit the risk of issuing the funds to business owners.
The SBA doesn’t offer this type of business loan, but it does provide the guarantee to minimize risk. For example, if you were to take out an SBA guaranteed business loan from a bank or another type of lender, the SBA would guarantee or promise to pay the lender a percentage of the value of your loan should you default.
The SBA can guarantee up to 85 percent of the value of the loan, which can make lenders feel better about their risk level.
The other way you can guarantee a business loan is with a personal guarantee. This means you are the one promising the lender that you will provide some type of collateral if you’re unable to pay the loan back.
The collateral is usually a personal asset that can be turned into liquid funds should your business be unable to generate the funds to repay the loan.
Since you’d give the lender a legal right to collect your asset to repay the loan should it come to that, this also minimizes risk on their part. Making a personal guarantee on a business loan should be a decision that’s approached with lots of careful thought and effective planning. After all, you will put your personal and business assets at a huge risk if you happen to default on the loan.
If you have both options, choosing a government-backed guaranteed business loan can provide more protection for both you and the lender.
Different types of government guaranteed business loans
Understanding SBA guaranteed loans can be tricky. Here are the details:
7(a) loans are the SBA’s most popular type of guaranteed business loan.
The SBA can guarantee up to 85 percent of loans of $150,000 or less and 75 percent of loans of more than $150,000. Depending on how much money you need, there may also be a guarantee fee to consider. The fee ranges from 0% for loans under $150,000 to 3.5% for loans over $700,000.
For loans over $1 million, there is an additional 0.25% fee charged. Keep in mind that your lender may pay these fees, or you may be asked to pay them in your loan terms.
You can borrow up to $5 million with this loan and use it for expenses like funding startup costs, buying equipment, and even to repair existing capital. You can also use this loan to take care of expenses that involve:
- Purchasing new land (including construction)
- Repairing existing capital
- Purchasing or expanding an existing business
- Refinancing existing debt
- Purchasing machinery, furniture, fixtures, etc.
7(a) loans are pretty flexible and provide longer terms than microloans. In some cases, they also have lower down payments compared to other business loans.
For example, 7(a) loans also offer working capital options which will provide a continuous flow of funds as needed along with a shorter repayment term.
Lenders have their own requirements, but to be eligible for an SBA-guaranteed loan, you generally need to:
- Have a for-profit business
- Do business in the U.S.
- Have invested equity
- Have a business that meets size standards
- Have revenue to demonstrate your ability to repay the loan
A 7(a) loan is repaid with monthly payments to cover principal and interest. The payment amount stays the same on a fixed rate loan, but for variable loans, the lender can allow the payment amount to change as the interest changes.
CDC/504 Loans are a form of SBA financing that allow small business owners to fund expansion efforts or modernization.
While 7(a) guaranteed loan funds can be used for a wide variety of purposes, a CDC/504 loan can be used for specific and generally larger expenses, such as:
- Purchasing existing buildings
- Purchasing land and land improvements
- Constructing new facilities or modernizing/renovating
- Purchasing long-term machinery
- Refinancing debt in connection with an expansion of a business through new or renovated facilities
This loan is a great option if you’re gearing up for a major expansion or construction project for your business. However, if you’re just looking for a loan to help you buy new basic office equipment, or to pay employees, this probably isn’t the best loan option for you.
This is a fixed-rate loan and while there is no maximum project size, the maximum SBA loan amount is $5 million. Small manufacturers or specific types of energy projects may qualify for a $5.5 million maximum loan amount.
To be eligible for a CDC/504 loan, you must:
- Be a for-profit business
- Fall with the size standards set by the SBA
- Have a business net worth not more than $15 million
- Earn an average net income of $5 million or less after federal income taxes filed two years prior to the application
The amount of loan funds you receive is a percentage of the value of the fixed asset you are purchasing. SBA lenders usually provide 90% financing, which means you’ll need to come up with a 10% down payment.
The project’s assets generally serve as collateral for the loan. A personal guarantee from owners of 20% or more is also required.
The interest rate for CDC/504 loans is the current market rate for five- and 10-year terms. Any additional fees may be financed with the loan.
Let’s say you don’t need to cover major business expenses for construction or refinancing and you prefer to borrow a smaller amount for your business.
Microloans are small, short-term business loans that are available to new startups, self-employed individuals and small businesses with only a few employees.
The SBA microloan program loans money to nonprofit lenders who then loan money to startups and businesses.
SBA Microloan amounts typically range from $500 to $50,000. Loan funds can be used for working capital, supplies, furniture, fixtures, machinery and equipment.
The maximum loan repayment term is six years and the rate is fixed. In terms of interest, there are some maximum rate limits put in place. Microloans that are less than or equal to $10,000 can have an interest rate as high as 8.50%, while microloans greater than $10,000 can have an interest rate as high as 7.75%.
This is lower than some business loans, but having a shorter term and borrowing less money means you can pay less interest if you repay your microloan quickly.
You can find local organizations that may provide microloan funding through the SBA by checking with your local SBA District Office.
Which loan is right for you?
Given the different options to obtain a guaranteed business loan, you want to carefully consider what your needs and preferences are for funding your business.
SBA guaranteed loans may be a better option over personal guarantee loans given the extra backing the SBA provides lenders with. Still, you’ll need to consider putting collateral down and making sure you qualify for the loan.
Keep the fee structures in mind for SBA guaranteed loans and realize that applying may be a lengthy process. You’ll need to submit credit and financial statements, as well as supporting documents that prove your business meets the SBA’s standards and qualifications.
The bottom line
All in all, the process could take weeks to months. There are quicker ways to get funding for your business through unsecured business loans, but you may be dealing with a much higher interest rate if you go that route.
SBA guaranteed loans still offer lots of flexibility and rely on other factors outside of credit. Determining your funding needs can be one of the best ways to determine which loan would work best for your business.
7(a) loans would be great for your mid-sized funding or working capital needs while microloans can help cover smaller start-up costs and ongoing business needs. You should only consider a CDC/504 loan if you’re planning to start a massive construction/remodeling project for your office or facility, or you need to purchase very expensive equipment for your business.
Having a solid business plan can also help you better narrow down your loan options, as you should ultimately use the funds to help improve or expand your business in some way.