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SBA vs. conventional loan: What you need to know

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Starting a business can be an expensive endeavor, especially with the COVID 19 pandemic still affecting the overall economy and supply chain. For business owners looking for funds to grow or launch their business, taking out a business loan can be a great option.

Many major financial institutions offer conventional business loans, a common source of funding for businesses. However, younger businesses may not qualify for conventional business loans, as newer businesses tend to have less credit history. Small Business Administration (SBA) loans are specifically designed for smaller, newer businesses, and could be a great option for those who can’t or don’t want to take out a conventional business loan. Here is what you need to know when deciding between conventional and SBA loans.

What’s the difference between an SBA loan and a conventional business loan?

Two of the main differences between a conventional business loan and an SBA loan is that an SBA loan typically has a longer repayment term and a lower interest rate than a conventional loan.

Both SBA loans and conventional loans for businesses are usually issued by banks. SBA loans, however, come from banks that participate in the SBA loan guarantee program. The program promises that the SBA will buy back a portion of your loan from the lender if your business fails and you default on the loan. An SBA guarantee typically ranges from 50 percent to 90 percent of the loan amount up to $5 million, depending on the loan program.

What is an SBA Loan?

The SBA is a government agency that partners with SBA-approved private lenders to offer a variety of loans for businesses that can’t get conventional loans. Depending on the type of loan you get, the SBA eliminates a percentage of the risk banks take on when funding young businesses.

One SBA loan option is the 7(a) loan program. As the SBA’s most popular loan program, 7(a) helps businesses finance startup costs, buy equipment and inventory, buy or expand existing businesses or obtain working capital.

Who it’s best for: SBA loans are best for new businesses that are in the U.S. and haven’t been in operation long enough to build strong credit histories.

Requirements of an SBA loan

To qualify for an SBA loan, the business must operate for a profit in the U.S. and the owner must have equity at stake. SBA loans also have eligibility requirements that businesses must meet in addition to lenders’ own underwriting criteria. These include but are not limited to the ability to repay the loan and good credit management history.

Businesses must also meet the program’s size standards for small businesses and are only eligible if they don’t otherwise qualify for conventional loans.

Key aspects of an SBA loan

  • Range of loan amounts: The SBA’s 7(a) Small Loan provides business loans of up to $350,000, while the Standard 7(a) Loan offers funding up to $5 million.
  • Longer loan terms: SBA loans have repayment terms of up to 25 years for real estate and 10 years for other fixed assets and working capital, which could make monthly payments more manageable. Conventional loans typically have terms up to 10 years.
  • Ideal for businesses with no credit or bad credit: SBA loans were designed for small businesses that wouldn’t qualify for a conventional loan at a bank.
  • You must meet SBA and lender requirements: The application process and approval can take longer, and businesses must meet eligibility requirements from both the lender and the SBA.

How to apply for an SBA loan

The first step to applying for an SBA loan is visiting SBA.gov and filling out the SBA Lender Match form. The form takes about five minutes to complete and asks applicants to describe their businesses and their needs.

Within two days, the applicant will receive an email with a list of lenders they’ve been matched with. The business can then contact the private lenders individually to compare rates, terms and other details before making a decision. Once a business decides on the SBA-approved lender they want to move forward with, they’ll submit an application directly with the lender.

What is a conventional business loan?

Conventional loans are typically offered by banks, credit unions and other financial institutions. In some ways, they function like personal loans in that lenders provide approved businesses with lump-sum funding and the businesses repay the loans (plus interest and any applicable fees) over an agreed-upon term.

Depending on your loan agreement, a business loan can be used to expand your business, buy business-related equipment or consolidate business debt. The loan can also be used as working capital.

Unlike with SBA loans, the bank shoulders 100 percent of the risk if your business defaults. Since conventional business loans have high stakes for private lenders, banks often require borrowers to have good credit.

Who it’s best for: A business that has been in operation for many years with a positive financial track record has the most to gain from a conventional business loan. If you and your business have high credit scores, private lenders might be more inclined to offer competitive interest rates. Low rates help you save money on the cost of borrowing, and fixed rates give you predictable monthly payments.

Requirements of a conventional business loan

A business looking for a conventional loan will need to demonstrate its ability to repay the loan. This includes providing the lender with a business plan that outlines its details and financial projections.

Financial institutions also require a good business credit score, as well as a strong personal credit score from the individual who’s representing the business. Businesses should also have low debt-to-net-worth ratios.

Key aspects of a conventional business loan

  • Requires strong business and personal credit scores: Because the lender absorbs all risks if a business fails and defaults on the loan, it will typically require strong credit scores to qualify.
  • May offer competitive rates: Because approval is highly dependent on credit, some conventional loans offer lower interest rates for businesses with high credit scores.
  • Difficult for no-credit or bad-credit borrowers: Young businesses without established credit or those with bad credit might face challenges getting approved. If they’re approved, the conventional loan rates will likely be high.
  • Variety of loans available: Private lenders offer conventional business loans in various amounts and with different terms and payment schedules.
  • Faster approval process: Lender approval is based on the bank’s underwriting criteria, meaning less paperwork and less time needed to make a decision.

How to apply for a conventional business loan

A business can apply for a conventional loan directly with a preferred lender. Many lenders accept applications in person at branch locations, over the phone and conveniently online.

Loan review and approval timelines vary from bank to bank.

SBA loan vs. conventional loan: Which is best?

If you’re looking for business funding and deciding between an SBA loan and a conventional business loan, you’ll want to explore both options before making a final decision.

Consider the stage of your business (e.g., a startup versus an established business), your credit history and overall financial health to help determine which option is best for you. You should also calculate the cost of a business loan to see which is the most affordable for you.

SBA loans and conventional business loans both come with their own sets of pros and cons, and no two lenders are the same regardless of which type of loan you choose. It is important to understand how both loan types, as well as individual lenders you consider, will work for your business’s specific needs.

Written by
Jennifer Calonia
Contributing writer
Jennifer Calonia is an L.A.-based writer and editor. She's covered topics like debt, saving money and credit cards. You can find her work on Business Insider, Forbes and more.
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Associate loans editor