There are many benefits for small businesses to apply for an (SBA) 504 loan such as lower down payment deposits on the loan, higher credit limits, competitive interest rates and many others that a small business otherwise would not be able to get through a traditional loan process. This is made possible because the SBA guarantees up to 85% of the loan reducing the risk that private banks take on when they offer loans to businesses taking advantage of the 504 program. In addition to guaranteeing up to 85% of the U.S. Small Business Administration (SBA) 504 loans for lenders, the SBA is taking further steps to reduce the financial risks for lenders. One vital initiative that SBA is taking is requiring the borrower, operating company, and applicable guarantors to provide an annual review to highlight the borrower, operating company, and applicable guarantors’ financial health each year.
The annual review reveals if a borrower is facing financial hardship which helps the lender determine if adjustments to the loan needs to be made. For example, if a borrower defaults on a loan or an obligatory payment such as property tax or commercial maintenance fee, the lender can choose to penalize the borrower by increasing the borrower’s interest rate to over 5%.
The SBA requires borrowers, operating companies, and applicable guarantors to do one or more of the following:
1. Share tax return
For most small business loans, SBA requires that an application for a business loan to contain, among other things, a description of the history and nature of the business, the amount and purpose of the loan, the collateral offered for the loan, current financial statements, and historical financial statements such as tax returns. Tax returns are effective documents to measure whether the borrower has sufficient income to pay its debts because tax returns disclose companies financial information such as their revenue and operating expenses including:
- Tax liability
- Gross rents
- Cost of goods sold
- Gross profit
- Capital gain net income
- Salaries and wages
- Repairs and maintenance
By assessing a borrower’s tax return, a lender can see if the borrower is afloat and is financially capable of repaying the loan.
To confirm the accuracy of a borrower’s tax return, SBA also uses Internal Revenue Service (IRS) verification of tax return and financial statement information to detect fraud by program applicants or participants. Source: Fraud Detection in SBA Programs.
Additional information about tax returns:
In order to comply with Section 2202 of the Taxpayer First Act (P.L. 116-25), SBA Lenders submitting an IRS Form 4506-T must obtain the borrower’s and seller’s (as applicable) written consent to the use of the tax return transcript(s) for the purpose of compliance with SBA Loan Program Requirements, including verification of financial information, verification of tax return filing, and verification of tax return information. Moreover, SBA Lenders must obtain the borrower’s and seller’s (as applicable) written permission for the SBA Lender to share the tax return transcript(s) with SBA and its agents for the purpose of compliance with SBA Loan Program Requirements, including discrepancy resolution, lender oversight activities, purchase reviews, complete file reviews, and other SBA reviews. Source: Lender and Development Company Loan Programs. If you have any questions about attaining the borrower’s written consent and submitting a request to IRS, please feel free to get in touch via phone at 1-800-SBA-REAL (722-7325) or contact form.
2. Provide proof of annual property insurance coverage
Insurance coverage must be at least equal to the outstanding principal balance of the loan or the maximum limit of coverage made available under the National Flood Insurance Act of 1968, as amended, whichever is less (source: Lender and Development Company Loan Programs). By reviewing the insurance coverage annually, the lender can assure that the borrower can repay the loan even if the borrower’s business encounters damages such as fire or break-ins and can’t operate at the highest efficiency. Ensuring that the borrower has insurance coverage that equals the outstanding principal balance of the loan reduces the lender’s risk tremendously to essentially zero. Failure to purchase a sufficient amount of insurance will make a borrower ineligible for a SBA 504 loan.
Additional information about the insurance coverage for specific insurance such as hazard insurance and flood insurance can be located at: U.S. Small Business Administration Insurance Requirements for SBA Loans. If you have any questions, you can contact us at 1-800-SBA-REAL (722-7325) or via a contact form.
3. Provide proof of annual secured property tax payment
When calculating repayment ability, a SBA lender can also look at the borrower’s cash flow and determine if it’s sufficient to cover the SBA loan payment in addition to the expenses of holding the property, including the payment of routine maintenance, utility expenses, insurance, all other ongoing expenses and property taxes. By viewing a borrower’s proof of annual secured property tax payment, a lender can acknowledge that:
- The borrower has used the loan to purchase a commercial property
- The borrower isn’t in financial hardship. If a borrower defaults on their property tax (or a loan in general), it signifies a financial hardship and raises a red flag to the borrower’s repayment ability to their SBA 504 loan in the future.
Penalties for Loan Defaults
If a lender finds out that a borrower has defaulted on a loan or obligatory payment such as property tax or operational maintenance fees, a lender may penalize the borrower by increasing the interest rate (sometimes up to 5.00% or more) until the specific item creating the default is resolved and the borrower has shown proof that shows that the borrower has remedied the specific item. A borrower can do one of the following to show that they’ve resolved the specific items that caused the loan default:
- Submit a tax return
- Provide property insurance coverage or proof of tax payment
- Make arrangements to pay in full/make a payment arrangement on their defaulted loan
- Make a plan to strengthen or improve their financial condition, which is acceptable to the Commercial Lender
In the extreme case, a Borrower may see the need to sell their Commercial property as a way to resolve a long-term hardship with no turnaround plan.
To avoid the possibility of penalties it is important that SBA loan holders submit their required documentation on time during annual requests from their CDC (Certified Development Company), BFC is a Certified Development Company that proactively communicates with clients to ensure they are compliant with SBA guidelines.
Do you have questions about SBA 504 loans? Please contact us at 1-800-SBA-REAL (722-7325) or using a contact form.