SBA Loan vs. Conventional Business Loan

SBA Loans provide a critical lifeline for small businesses that don’t qualify to receive funding from traditional lenders. These loans typically have manageable fees, longer repayment terms, and lower interest. However, conventional loans might still be the best choice for most small businesses. 

SBA loans take a notoriously long time to fund, not to mention the extensive paperwork and lengthy application process. So we’ve put together this detailed comparison to help you decide which loan option is better. 

SBA Loan Pros and Cons 

Pros 

  • Lower interest rates 
  • Capped interest rates 
  • Flexible loan options 
  • Longer repayment terms 

Cons

  • High denial rate by lenders 
  • Slow approval process 
  • Extensive paperwork 

Conventional Loans Pros and Cons 

Pros 

  • Faster application and approval process 
  • Fewer restrictions 
  • Multiple loan options 
  • Competitive interest rates 

Cons 

  • Shorter repayment terms 
  • Strict collateral requirements 
  • Higher debt service requirements 

Loan Type: Conventional Business Loan Wins 

Your lender must have the type of loan product or financing to suit your business funding requirements. Diverse loan options also help you compare interest rates and terms to find the perfect financing for your situation. 

The SBA has several types of loan programs, including:

7(a) Loans – This is the most common type of SBA loan. You can use these funds to cover various business expenses, including working capital, purchasing leasehold improvements, new equipment, or real estate. You may qualify for up to $5 million. The SBA guarantees up to 85% for loans up to $150,000 and 75% if you borrow more than $150,000. The typical SBA turnaround time for this type of loan is 5-10 business days. 

SBA Express Loans – The SBA offers quick loans of up to $500,000. This program covers term loans and business lines of credit (LOCs). Again, you can use this loan for most business needs, including maintaining working capital or refinancing certain types of business debts. The SBA backs up to 50% of the loans. The typical turnaround time is 36 hours. Plus, lenders can make a credit decision without a review from the SBA. 

504 Loans – This loan targets businesses wanting to purchase significant fixed assets such as commercial equipment or real estate. You can qualify for up to $5.5 million. You need 50% lender funding, 40% Certified Development Company (CDC) funding, and 10% personal downpayment. This type of loan is 100% SBA guaranteed. 

Microloan Program – The SBA offers small loans of up to $50,000 to underserved markets such as lower-income families. Interest on these loans is capped at 9%. 

Similarly, there are multiple types of conventional business loans, including:

  • Term loans
  • A business line of credit (LOC)
  • Equipment loans 
  • Invoice financing 
  • Merchant cash advances
  • Personal loan for business use
  • Microloans 
  • Working capital loan 
  • Accounts receivable factoring 

The SBA offers the basic types of loans that most businesses require. In addition, its programs cover additional business needs, such as disaster discovery or importation. Still, conventional loans offer far more options. 

For example, accounts receivable factoring allows you to cash in on sales on credit terms. Similarly, invoice financing will enable you to use unpaid invoices as collateral for a cash advance. Unfortunately, the SBA doesn’t offer these types of purpose-made loans. 

Lender Type: Conventional Business Loan Wins 

It’s worth noting that the Small Business Administration doesn’t lend money itself. Instead, the SBA works with a network of approved lenders, including banks, microlending institutions, community development organizations, and alternative lenders.  For example, you can apply for an SBA loan from SmartBiz, an SBA-approved lender. Then, the SBA may cover up to 85% of your debt if you cannot pay it and your loan goes into default. 

Screenshot of SmartBiz home page

This situation means that you typically have to go through two approval processes. First, you’ll need to fill out an SBA Lender Match form. Next, you’ll receive a list of lenders that match your criteria, which takes about two days. Finally, you’ll apply for an SBA-guaranteed loan with your chosen vendor. 

Alternatively, you can apply for an SBA-backed loan directly from a lender. The lender will assess your application and decide whether you qualify for the loan. Finally, the lender will apply for SBA-backed loan status on your behalf. 

However, meeting the SBA minimum requirements or getting SBA approval for guaranteed loans doesn’t mean you automatically qualify. In most cases, the lender still has the final say on whether you are eligible for funding. This can be an issue if the SBA and your lender have different requirements. 

Following the same example, SmarBiz has minimum credit score requirements for SBA loans. For instance, you’ll need a credit score of at least 650 to qualify for an SBA 7(a) loan and a minimum credit score of 675 for a commercial real estate loan. However, the SBA has far more lenient credit score requirements, sometimes as low as 155.

These conflicting requirements can make accessing SBA loans more complicated than it needs to be. Borrowing directly from the lender is more accessible in most cases. You immediately know if you qualify for a loan. 

The only exception is lenders under the SBA Preferred Lenders Program (PLP). These institutions have the authority to approve or reject SBA loans without a review from the Small Business Administration. So, make sure you work with a PLP-certified lender to improve your chances of qualifying for the loan or expedite the approval process. 

In short, you’ll likely be using the same lender whether you decide to get an SBA or a conventional business loan. In addition, while most lenders offer different types of conventional loans, not all of them underwrite SBA-backed loans. Therefore, you have more options if you apply for a conventional loan. 

Funding Needed: SBA Loan Wins 

Conventional loans offer high funding amounts. However, there are strict credit score requirements and other eligibility criteria for higher amounts. As a result, most small and new businesses find it challenging to access funding for significant investments such as new construction or expensive equipment. 

The SBA makes businesses with poor credit histories more attractive to lenders. A bank or other financial institution will likely overlook a low credit score or insufficient collateral if the SBA guarantees your loan. 

Again, you’re still required to repay the loan. However, lenders have the incentive to be more lenient with borrowers that otherwise don’t meet their stringent qualification criteria. As a result, you may be eligible for up to $5 million, with the SBA guaranteeing up to 75% of the loan amount. 

Interest Rates and Loan Terms: SBA Loan Wins 

The main advantage of SBA loans is the favorable interest rates and loan terms they attract. This reason might be enough for going through the rigorous process of applying for an SBA loan. 

However, most SBA-backed loans require a deposit. Some lenders also require a deposit before closing the loan. This deposit is usually charged as a percentage of the principal loan. 

The SBA also imposes a maximum interest rate. Most of these loans are under 8% interest. So you’re less likely to fall into the hands of predatory lenders if you choose an SBA loan over a conventional loan. 

Furthermore, most SBA loans have a term of five to 10 years. This is sufficient time for most businesses to repay their debt. This term length is desirable for small businesses and startups. 

SBA-backed loans also mean that you don’t shoulder the entire risk of your loan. Sure, you still have to repay the loan. But, the SBA can pay up to 85% of your loan if you default due to unforeseen financial difficulties. 

This arrangement saves your personal or business assets from liquidation. You can renegotiate better terms with the SBA. Most lenders aren’t as forgiving as the Small Business Administration if you default on your loan. 

Qualification Requirements: Conventional Business Loan Wins

Qualifying for a business loan requires you to demonstrate your creditworthiness. These requirements vary depending on the financial institutions. Some of the criteria banks, credit unions, and alternative lenders look at include:  

  • Business and personal credit scores 
  • Annual business revenue and profit 
  • Time in business 
  • Debt service coverage ratio 
  • Debt-to-income ratio 
  • Business plan 
  • Collateral 

You’ll also need to submit various documents, including bank statements, balance sheets, personal and business tax returns, legal contracts and agreements, Employee Identification Number (EIN), and incorporation documents. Again, this list of documents varies depending on the lender. Some lenders have more lenient requirements, especially if you have a strong credit history and valuable collateral backing your loan. 

The specific requirements for SBA loans depend on the loan you’re applying for. However, there are overarching requirements, including:

  • Meet the SBA definition of a small business 
  • Be registered as a for-profit business 
  • Have partial or full ownership of the business 
  • The business must be located and operate in the U.S.
  • Have exhausted other financing options 
  • Not default on government debts

Similarly, you’ll need to submit various documents, including a business plan, basic business information, personal and business tax returns, personal background, and personal and financial statements. The SBA will consider these requirements and documents when assessing your eligibility for its programs. 

Furthermore, you must fill out various SBA-specific forms when applying for your loan. These forms may include:

  • SBA Form 413 – Personal Financial Statement 
  • SBA Form 108 – Personal Guarantee 
  • SBA Form 159 – Personal Disclosure Form 
  • SBA Form 912 – Statement of Personal History 
  • SBA Form 1919 – Borrower Information Form 

As you can imagine, it takes time for the SBA to process all these requirements and documents. You still need to apply for the loan directly with your lender. So, you’re essentially submitting double applications. 

SBA loans are also highly competitive. That’s why they have a significant rejection rate by the SBA and lenders alike. The best advice is to work with an SBA loan expert to help you file your documents and assess your eligibility. 

Otherwise, conventional business loans are more accessible. Many lenders specialize in loans for businesses with poor credit. It might be easier to explore traditional term loans before applying for an SBA-backed loan. 

Furthermore, the SBA requires lenders to take collateral for some types of loans. For instance, lenders offering SBA 7(a) loans must take collateral for loans over $25,000. Therefore, a conventional loan might be your only option if you need an unsecured loan of more than $25,000. 

Funding Time: Conventional Business Loan Wins 

Except for Express Loans, SBA loans typically have a long funding time. The application process is lengthy and time-consuming. Furthermore, you’ll still have to wait longer, even after your SBA loan has been approved. 

For example, it takes up to two weeks to receive a letter of intent from the SBA. This document specifies your loan terms, including how much you qualify for, your interest rate, and other terms. Furthermore, the SBA may take up to four weeks to formally underwrite the loan. 

Conventional loans may time some time to fund. Still, there’s less waiting time and bureaucracy compared to SBA-backed loans. Some lenders even process loans the same day or the next day. SBA loans aren’t ideal if you need funding immediately. 

Fixed vs. Variable Interest Options: Conventional Business Loan Wins 

A fixed interest rate doesn’t change for the term of the loan. Some borrowers prefer this type of rate. It is predictable, and interest payments don’t rise based on changes in the market. Most conventional loans offer fixed or variable interest, depending on your preference. 

Variable interest rates change depending on the market conditions. This means you could pay higher interest than anticipated, especially during volatile markets. The SBA only offers variable interest rates. 

The interest rate is based on the daily prime rate and leader spread. Depending on Federal Reserve actions and policies, this prime rate is subject to change. So, again, you may pay more or less interest depending on market conditions. 

This uncertainty can make accurate financial planning and projection more difficult. 

Final Verdict 

SBA loans do a terrific job of getting funding to businesses that traditional lenders consider risky. For example, an SBA loan might be the only option for startups or businesses with poor credit or who don’t qualify for a conventional loan. However, the tougher SBA loan application process makes it a second choice to conventional loans. 

Conventional loans offer multiple benefits and are better suited for small businesses. You can typically expect quicker approval times, less documentation, and flexible interest rates. 

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