The prospect of taking an SBA can be enticing. No collateral required. Only 10% down. When lenders say no to traditional commercial loans, the SBA loan option appears and saves the day. The SBA loan is the hero of the people, the last hope when there are no other avenues to finance your dream of owning your very own business. But before you take the leap, there are some important things you need to know. This list is not meant to discourage you from taking the loan, but rather is an attempt to make sure you walk in with your eyes wide open.
- The Personal Guarantee – The way that the SBA entices banks to make loans that they would not otherwise make is by offering a guarantee to the bank. Provided that the bank correctly follows protocol with regards to underwriting and servicing, the SBA will reimburse the bank (usually for around 75%) if the borrower defaults on the loan. Many people mistakenly believe that the SBA guarantee means that if they take the loan and cannot pay it back, that 75% of debt gets forgiven, meaning that they are off the hook and don’t need to repay the loan. This is not the case. A personal guarantee means that you personally are responsible for the debt, regardless of how much the government reimburses the bank for. If you default on the loan, you will still responsible to repay the debt out of your personal assets. This means savings, investments, your wages (if you work a salaried job), or even your home.
- If you pledge your home, you could lose it – From time to time, I hear stories from panicked clients about how when they first took the loan, their loan officer told them that after 18 months, the bank would be willing to release their home, but at the outset of the loan, the borrower would have to pledge it as collateral for the loan. Fast forward 18 months, the bank has no interest in releasing the home, and to make matters worse, the business is struggling. The important thing to remember is that unless you have in writing (preferably in the loan documents), it’s going to be hard to convince the bank 2 years later that you were promised something by your loan officer. If your home is pledged as collateral, and there is equity in it, your bank may foreclose on it in order to recover the loan proceeds.
- Settlements Are Not Guaranteed – When things get tough for your business and it fails, settling your loan is an option that many people choose to pursue. With that said, the process is not always an easy one to navigate. Workout people can be rude, incompetent, and unresponsive. And when that happens, my clients often demand action. But in certain cases, the radio silence we hear from the bank is intentional. They have no interest in settling. And make no mistake, they aren’t required to settle. Just because you don’t want to borrow all the equity in your home or empty out your savings doesn’t mean they must accept whatever you offer.
- Variable Interest Rates Are Silent Killers – When I worked for the biggest SBA lender in the country, interest rates on most 7a loans were almost always variable. They were tied to Prime rate, and when the prime rate increased, so did the borrowers loan payment. For smaller loans, it may not be noticeable but when you owe $500K, $1 Million, or more, it could increase your payments dramatically over time. When shopping around for an SBA loan, you may want to consider a fixed rate. The rate may be higher to start, but if rates jump, you’ll be glad you did.
- Defaulting Can Impact Your Ability To Borrow In The Future – When borrowers can’t repay their loan, or even when they settle their loan, this information is retained by the SBA. They are like an jilted lover. Fool me once, shame on you. Fool me twice, shame on me. What I’m trying to say here is that if you fail to repay one SBA loan, it’s unlikely that you’ll be approved to get another. And recently, the SBA has been reporting settlements to credit bureaus, which could impact all sorts of borrowing needs.