A couple of months ago one of our clients, an SBA Lending Manager who’s an old buddy of mine, asked me to review his SBA lending policy, specifically to amend it to include 504 loan refinance products:

OLD BUDDY. Richard, as you know, we originate many 7(a) loans annually, but we’ve had few 504 originations. When our lending policy was written a few years ago, the 504 program didn’t encompass refinancing. Now that interest rates have been increasing, we’ve seen significant demand for refinancing some of our variable rate loans with a fixed rate product.

ME. Not surprising. Given that a 7(a) loan rate of prime + 3 isn’t unusual, there’s increased demand for refinancing. What did you think about the changes to your policy that I recommended?

OLD BUDDY. As I suspected, we’ve got some updates to make. For example, I had no idea that SBA has a product allowing for a 504 loan both to refinance existing debt and finance an expansion. What limits are there on expansion financing? Is there a maximum percentage of the loan that can be used to refi? And is there a minimum amount of the loan that needs to be used to refinance debt if you’re adding funds for expansion? Please expound

ME. Hmm. Me expound? Glad you asked!

Short Answer: There’s no minimum refinance amount if the loan proceeds will also be used to expand. Everything begins with eligible project costs, as is the case with 504 loans.

Let’s start with the eligible expansion costs. They’re just the same as for a plain old ordinary down-and-dirty 504 loan: land; building; equipment, etc. Let’s say your expansion costs will total $1 million. And let’s say the borrower wants to refi another $200,000 in debt. If at least $170,000 of that $200,000 (85%) was incurred for costs that would have been eligible under the 504 program, then the whole $200,000 can be added to the refi. Now you have a $1.2 million project.

If the refi costs are eligible and the expansion costs are eligible then the whole loan amount is eligible. (I think there is an algebraic equation that comes close to expressing that, but if so, I’ve forgotten its name.)

OLD BUDDY. Thanks, Richard. I’m also wondering if there is a limit to the amount of loan proceeds that can be used for expansion.

ME. Okay, I know the current SOP says that indebtedness to be refinanced cannot exceed 50% of the cost. But the SOP was changed by SBA in an Interim Final Rule issued on July 29, 2021 that eliminated the 50% ceiling. So there’s no limit to the percentage of loan funds that can be used for refinancing.

Just as with regular 504 loans, there are limits to the minimum and maximum size of the 504 loan (generally $50,000-$5 million). The CDC might turn down a request for a $50,000 504 loan in second lien position to a $31 million first. But there are no regulatory limits to the amount of financing, that is, TPL + 504 loans.

OLD BUDDY. What about loan to value?

ME. Thanks for asking, old pal. This gives me a wonderful opportunity to disabuse lenders everywhere of the notion that the 504 program has LTV limitations.

There’s only one time in the 504 program that SBA has a maximum LTV or even uses the expression. And that is if the loan is for refi without expansion, But that’s whole other subject upon which I could expound. Fodder for future eBulletins!

Richard Jeffrey
Senior Associate, CDC/504 Loan Program