- U.S. Small Business Administration (SBA) and conventional bank loans offer businesses low interest rates and fixed terms.
- There are several differences between SBA and conventional bank loans that could impact your borrowing decisions.
- SBA loans have longer approval times and require more documentation. They are a great way to finance long-term purchases.
- This article is for business owners considering an SBA or conventional small business loan.
Whether you need short-term funding or help paying for expensive equipment, U.S. Small Business Administration (SBA) and conventional bank loans are popular options, and for good reason. Both offer lower interest rates, but that's where the similarities end. There are distinct differences between the two types of loans that would-be borrowers need to understand.
What is an SBA loan?
SBA loans are small business loans that are guaranteed by the federal government. The SBA backs the small business loans issued by approved lenders, guaranteeing up to 85% of the loan value. That alleviates a lot of the risk to the lender if the borrower were to default.
"We provide that guarantee that allows [lenders] to be more generous in their terms," said Dianna Seaborn, director of the office of financial assistance in the SBA's Office of Capital Access. "That generosity helps the small business in cash flow and repayment terms – it helps them to get financing when they're startup businesses."
Interest rates on SBA loans range from around 3% to 7%. That's much lower than credit cards and alternative small business loans. [In the market for a small business loan? Check out our reviews of the best financing options.]
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There are three main types of SBA loans:
- 7(a) loan: This is the SBA's main loan product for small businesses. Interest rates vary based on the borrower's credit score. With this loan, you can borrow up to $5 million.
- SBA microloans: These are SBA-backed microloans ranging from $10,000 to $50,000. Designed for small startups and borrowers with limited collateral and/or sales, they can be used by companies that need a small financial boost.
- 504 loans: These are long-term, fixed-rate loans used for expansion and/or modernization. These loans can be used to purchase large pieces of equipment or real estate. Terms for these loans can last 10, 20 or 25 years.
[Read Related: Small Business Financing Trends]
What is a conventional loan?
Conventional small business loans are typically provided by banks, credit unions and financial institutions. The lenders give you a lump sum of money that you're required to pay back over a fixed period of time. Interest and fees are included with the loan and vary depending on your credit score and the lender.
Just like SBA loans, they can be used to cover business expenses, purchase equipment, or they can be used for working capital. Conventional small business loans aren't backed by the government like SBA loans are. That means the bank shoulders 100% of the risk if the borrower defaults. As a result, most conventional small business loans require you to have a good credit score, strong financials and have an established track record as a business owner.
An SBA loan vs. conventional loan
SBA loans differ from conventional business loans in many respects. The rates and terms vary, as does the risk that the lender is assuming. Here are some other differences between an SBA loan and a conventional business loan.
SBA loans require more paperwork than conventional bank loans.
Alex Espinosa used to run the SBA loan departments at various banks and now works as an SBA lending consultant through his company, BOLD Lender. He said there are some barriers that both lenders and borrowers face with SBA loans.
"It's very complicated to the average banker," he said. "It's not complicated once you're mentored through the whole thing and spend a few years in it."
SBA loans differ from conventional bank loans in that the borrower usually has a "riskier" financial profile compared to individuals applying for a conventional loan from a bank. This means one thing: paperwork. The SBA needs a lot more information from you and the lender to guarantee the loan. However, by partnering with a bank or lender that has an experienced SBA department, Espinosa said the loans can be completed with minimal headaches.
SBA loans are more complicated.
As with any government-backed process, there is a long list of regulatory rules and processes that lenders must abide by. This discourages some lenders and creates longer funding times, especially compared to conventional lenders or alternative online lenders.
"To get an SBA loan, the paperwork [requires providing] more documentation, … and the process to get approved … is going to be longer than some of the other small business loan products that are out there today," said Joe Camberato, co-founder and CEO of National Business Capital.
SBA loans typically have longer approval times.
Camberato and Espinosa said the SBA approval process can take between 60 and 120 days to complete. Many alternative lenders may be able to provide lightning-fast turnaround – sometimes providing funding in just a few days – but they aren't subject to the same regulations, and they will almost always charge higher interest rates.
SBA loans offer low interest rates.
The maximum interest rate on an SBA loan is 8% as of April 2021. That's much better than the rates you'll pay with alternative lenders, which can be high depending on your credit score.
SBA loans have longer repayment terms.
Another advantage of SBA loans is they come with longer terms, which means lower monthly payments for business owners. Both 7(a) and 504 loans have terms that range from 10 to 25 years. Depending on your agreement, you could be set up with a fully amortized loan. This means you pay both interest and principal with every payment as the loan matures so it is completely paid off by the end of the agreed-upon term. Some conventional bank loans have a balloon payment stipulation, which means you're required to come up with a sizable payment when the loan matures. This can be crippling for some business owners.
SBA loans are more flexible.
If your business experiences financial hardship, or you fall behind on payments for some reason, SBA loans have some flexible options to help you stay on your feet. Espinosa said companies may be eligible to defer payments or provide interest-only payments.
"The SBA has some flexibility that they allow the banks, which the banks don't always use as they should when someone's in trouble," he said. "The last thing the SBA wants to do is have you foreclose."
It's easier to qualify for an SBA loan than a conventional loan.
One of the biggest advantages of an SBA loan is that you can get a loan without meeting the stringent qualifications a conventional lender may require of its loan applicants. This makes the SBA program a great option for new businesses or businesses with limited collateral. Espinosa said an SBA loan will never be denied because of a lack of collateral.
"The rule is that the SBA will not turn down a loan for a lack of collateral, but the rule is they want all available collateral to secure the loan," he said. This likely will include a personal guarantee and other assets.
Is an SBA loan or a conventional loan better for me?
The SBA loan program may be better suited for your business, but it depends on your situation. Camberato said SBA loans are a good option for businesses looking to make lasting expansions or improvements to their existing building, for example. He also said larger loans for bigger projects make for great SBA loans. Whether you're in the market for financing or not, Seaborn said the SBA has many resources to help business owners grow.
"We do a lot as an agency to support your understanding of what we do," she said. There's the "ability to access free counseling and support from small business development centers, business-plan writing, marketing feasibility, and those kinds of things, all the way to the point where you are in the market for financing."