As economic trends continue to shift, SBA loans are becoming more important than ever for entrepreneurs, economic and business development, and the sustainability of commercial lenders. In this article we explore the reasons that borrowers are choosing to work with SBA-approved lenders and how financial institutions can use digital lending tools to incorporate more profitable SBA lending arrangements into their current loan portfolios
The basics of SBA Loans
SBA loans are lending programs where a portion of the funds are government-backed, reducing the risk for the financial institutions that issue the funds and increasing the approval rates for borrowers. SBA-guaranteed loans are backed by the U.S. Small Business Administration, which is a federal agency that focuses on promoting the growth and development of small businesses across the country. Since its inception in 1953, the SBA has facilitated more than 20 million loans, guarantees, and other forms of assistance to small business owners. In addition to working with SBA-approved lenders on small business financing, the SBA also offers business and finance counseling, industry education, and support services to encourage the success of both new and established entrepreneurs.
There are several SBA loan programs, most of which work in a similar fashion to a conventional business loan. For borrowers interested in SBA loans, the guidelines determining eligibility requirements, permitted use of funds, maximum loan amounts, and loan terms are set by the SBA, but the funds are issued by an SBA-approved lender. Many traditional lenders, like banks and credit unions, as well as alternative lenders and online marketplaces have been approved to issue these loans and can be found through the SBA’s lender match tool. The lenders handle the application and underwriting process following the SBA guidelines, but have ultimate control over credit decisions and funding methods.
SBA loans have become a popular financing option for small businesses for several reasons including lower down payments, fewer financing costs, and lower interest rates than traditional bank loans. The ongoing support offered by the SBA after the loan is funded is another reason their loan programs remain in high demand for startup entrepreneurs and any small business owners because it gives them access to the capital they need for working capital, renovations, inventory, or large purchases like commercial real estate and other business assets while providing business training and resources.
The benefits of Issuing SBA loans In today’s market
Borrowers benefit from SBA loans because it provides a safe and secure way to access the capital they need to run and grow their businesses. Financial institutions also benefit from working with SBA-guaranteed borrowers because government-backed funds help to diversify their loan portfolios while reducing risk and increasing loan revenue.
There are several different types of SBA loan programs, so lenders and borrowers can review multiple financing arrangements before selecting one that best suits the business needs of the borrower. SBA loan amounts range from $500 to $5.5 million and depend on several factors including the creditworthiness of the applicant, the intended use of funds, the lender, and the type of SBA loan program.
- SBA Microloans – With an average approved loan limit of $13,000, the microloan program offers the smallest loans backed by the SBA. Microloans provide loans up to $50,000 to help small businesses and certain nonprofit childcare providers get started or expand. The SBA guidelines allow Microloan proceeds to be used as a supplement to fluctuating cash flow for purchasing inventory, furniture, or making large purchases of equipment and machinery, but microloans can’t be used as to pay off other debts or to buy real estate.
- SBA 7 (a) loans – The most poplar group of SBA loan programs, SBA 7(a) loans approve loans up to $5 million for approved borrowers while guaranteeing portions of the total amount funded, capping interest rates and limiting fees. One of the most attractive characteristics of the 7(a) loan is that the proceeds can be used for almost any business need including acquisition, operating expenses, working capital, real estate, startup costs, new construction and renovations. SBA 7(a) loans can also be used as a refinancing tool to pay down higher interest business loans.
- 504 Loans – Also called the Certified Development Company (CDC) loan program, SBA 504 loans are long-term, fixed rate financing options for businesses to purchase or repair real estate, equipment, machinery, and other fixed assets. The program, in which the SBA partners with certified CDCs to approve loans up to $5.5 million in an effort to promote business growth, economic development, and job creation.
Recent bank collapses and ongoing interest rate hikes continue to shift the lending industry towards increasingly stringent standards. With higher credit score requirements, fewer businesses will qualify to obtain a loan in the full requested amount. As lenders slow their loan approval rates, small businesses may need to wait longer to receive any loan amounts for which they receive approval. The change in industry approvals mean that lenders and borrowers are working with SBA loans as a lower risk alternative.
Eligibility requirements for SBA loans are determined by the lender, the type of loan program, and the purpose of the loan. SBA loans offer better approval rates than traditional bank loans and business line of credits because eligibility is based on more than the borrower’s credit history. Applicants that have had trouble qualifying for other loan programs can qualify for an SBA loan based on the business’s operations, business plan, location, and the character of the business owner. Although each loan program may have its own approval requirements, all SBA loan programs require that borrowers be a for-profit business that is physically located in the United States. SBA loans also require that the owner has invested equity in the business and has exhausted other financing options.
The low interest rates and origination fees of SBA loans are often better options than other financing options, like credit cards or short-term loans, that may require entrepreneurs to use revenues as collateral, provide a personal guarantee, or make a considerable down payment. As the Federal Funds rate continues to influence rising interest rates, credit card interest rates have reached an average of 20%. Since most credit cards have a variable interest rate, yesterday’s rate increase directly impacts credit card interest rates. 20% rates reflect an all-time high from March 2022, when the rates hovered at 16.25%. For small businesses that have relied upon credit cards, the interest rate on the cards creates an even larger challenge for businesses that struggle with cash flow. SBA loans provide a viable solution to these borrowers.
Inflation occurs when the cost of products and services increases, creating a decrease in the purchasing power of consumers, and ultimately the value of the dollar. As of April 12, 2023, the inflation rate is 5.0%, which is down from the 2022 rate of 9.1%. The changes in inflation are driven by a combination of demand and cost factors. Demand-driven inflation describes the effect on the economy when consumer needs exceed the current supply. Cost-driven inflation, or cost-pull, happens when businesses raise prices because of a supply shortage and is usually a result of natural disasters, taxation, or supply chain issues.
Current economic trends are still a major factor for financial institutions, small business owners, and consumers. Keeping business growth in pace with the rate of inflation has been exceptionally difficult. Owners would need to grow business profits by 6.0% annually to match inflation rates. For those whose businesses have not grown as rapidly, owners are left to cover the additional cost of goods. To face adverse market conditions, business owners are urged to secure capital before they need it. SBA loans offer a haven to entrepreneurs. Since SBA loans’ underwriting and credit requirements do not shift with market conditions, they continue to provide the lowest interest rate loans.
How financial institutions can better manage government-backed lending programs
As financial institutions recover from the pandemic and rising inflationary rates, many lenders are still dealing with losses created by the 2021 surge in PPP lending. Since the Paycheck Protection Program is no longer accepting applications, lenders have the opportunity to restore and expand their loan portfolio. One way to maximize earning and performance potential is to partner with the right digital SBA Lending Platform, like the Biz2X Accelerate SBA platform.
The Biz2X Accelerate SBA platform empowers financial institutions to issue loans under government-backed programs, like SBA 7(a) and Microloans. The end-to-end digital loan management tool can help lenders:
- Go digital – The end-to-end digital loan management software offered by Biz2X digitizes the loan process by allowing loan officers to electronically fill out and submit SBA forms into the E-trans system.
- Simplify the process – The SBA platform reduces complexity in the loan application process with automated eligibility evaluations based on SBA eligibility requirements and the specific credit criteria of the fund issuing institution. Customers upload application documents including bank statements, income tax returns, financial statements, and legal correspondences into the digital platform increasing security and expediting the approval process.
- Grow loan portfolios – Increased efficiency in the underwriting and funding processes gives lenders the opportunity to work with a larger number of clients in the same amount of time. Loan decisions can be presented to borrowers within fewer business days than manual underwiring processes because automated financial calculations and reduced paperwork requirements.
Other features of the Biz2X Accelerate SBA platform include a banker dashboard, which provides an all-in-one portal for underwriting, risk and offer management, client communication, and reporting. The dashboard is customized to match the lender’s credit policies, allowing the institution to remain in control of credit decisions.
One fascinating example of maximizing potential through digital SBA lending with Biz2X can be explained in the story of Popular Bank, one of Puerto Rico’s leading financial institution. When the bank was looking to increase their digital banking services and grow small business lending by more than 50%, COO Manuel Chinea knew it was time to revise the manual underwriting system used by the bank. After making the switch to the Biz2X Platform for loan origination, portfolio management, and underwriting, Chinea saw increased approval turnaround, better risk management, and increased market penetration.
As interest rates rise and small business owners continue to navigate recession threats, more and more lenders and borrowers are turning to SBA-backed loans like the SBA 7(a) loans, Microloans, 504 loans, Expressloans, and Caplines. While these government-backed loans reduce risks for financial institutions, the increased paperwork and underwriting demands can become overwhelming. Utilizing a robust digital lending platform, like the Accelerate SBA Platform from Biz2X, is one way lenders are using SBA lending to increase loan revenues, lower portfolio risk ratings, and cut down on manual underwriting and credit monitoring processes.