Eve called the other day with a “smashingly good idea” for increasing her CDC’s 504 volume and wanted to run it past me. I’m always game for smashingly good ideas, so I was all ears, as they say. Here’s how it went:

EVE. Richard, 7(a) interest rates are high right now and go up every time prime moves. With a prime of 8.5%,  7(a) rates are 11.5% and could go higher. Surely, it’s time to tell 7(a) borrowers that they can refinance their variable rate loans with a fixed rate 504 loan and save some money!

ME. Eve, congrats on a good idea, but I need to temper your enthusiasm somewhat. As you know, to refinance a loan you must demonstrate that at least 85% of the original loan proceeds was used to acquire a 504-eligible fixed asset. So you need to find out the use of funds at the time the 7(a) loan was funded. The loan settlement statement, SBA Form 1050 is a good place to start. If 85% of the original loan proceeds would have been eligible for 504 financing, you’re off and running.

EVE. Hmm. Maybe  I can just refinance the part of the loan that paid for 504-eligible project costs.

ME. Nope. Like the song goes, “All or nothing at all.” The entire loan must meet the 85/15 test to be eligible for refi with a 504. And if the entire 7(a) loan isn’t refinanced with a 504, the remaining balance must be taken care of, e.g., paid off in cash. Bottom line: If you’re refinancing a loan, you’re refinancing the whole loan.

EVE. Okay, I got that. What else do I have to do?

ME. Well you also have to verify in writing that the 7(a) lender is unable or unwilling to modify the current payment schedule. That will require some diplomacy on your part. If the lender sold the 7(a) guaranty, the lender probably won’t be able to modify the note without buying back the guaranty. And that could include paying back the secondary market for any premium it paid when it bought the guaranty.

But suppose the 7(a) lender is getting 11.5% on its loan. They won’t be highly motivated to modify the loan terms to match the terms of a 504 loan. On the other hand, they might realize that if they say they’re unwilling to modify the current payment, the borrower will just pay them off. Then, they’ll need to find a new borrower to replace the loan. That might be a challenge. Everything I read nowadays tells me that commercial loan criteria have become more restrictive.

EVE. Whew! This won’t to be so easy. My smashingly good idea just got harder.

ME. Yep. Isn’t that why you called us?

At JRB, we’re here to help tackle the tough issues. Including issues like this. Keep your smashingly good ideas coming!

Richard Jeffrey
Senior Associate, CDC/504 Program