Everything You Need To Know About SBA Loan Early Payoff Penalties

If you have taken out a loan from the Small Business Administration (SBA), you may be wondering if there are penalties for paying it off early. SBA loans are beneficial for small business owners because they offer lower interest rates and better terms than conventional bank loans. However, some SBA loans do come with prepayment penalties if you pay them off too soon.

In this comprehensive guide we will cover everything you need to know about SBA loan early payoff penalties including

• What is an SBA loan prepayment penalty?
• When do SBA loan prepayment penalties apply?
• SBA 7(a) loan prepayment penalties
• SBA 504 loan prepayment penalties
• How to calculate SBA prepayment penalties
• Tips for avoiding prepayment penalties
• Is it ever worth paying the penalty?

What Is An SBA Loan Prepayment Penalty?

A prepayment penalty is a fee that you have to pay if you pay off your SBA loan earlier than the full loan term. SBA loan terms are usually 10-25 years, so if you pay it off in 5 years you may trigger a penalty.

The prepayment penalty compensates the lender for the lost interest they would have earned if you paid over the full term. Most non-SBA loans do not have prepayment penalties, but they are common with SBA backing.

When Do SBA Loan Prepayment Penalties Apply?

Here are the basics on when SBA prepayment penalties can happen

• SBA 7(a) Loans: Only apply if the loan term is 15 years or longer. Penalties apply only during the first 3 years.

• SBA 504 Loans: Apply for the entire 10 year penalty period regardless of loan term.

The specifics depend on the loan type as we will explain more below. The prepayment penalty periods always start from the date you originally get the loan funded.

SBA 7(a) Loan Prepayment Penalties

For SBA 7(a) loans with terms under 15 years, there is no prepayment penalty at all. You can pay it off whenever you want with no fee.

However, for SBA 7(a) loans with a 15 year or longer term, prepayment penalties do apply as follows:

• Year 1: 5% of the prepayment amount
• Year 2: 3% of the prepayment amount
• Year 3: 1% of the prepayment amount

After the 3 year period is over, there are no more prepayment penalties on SBA 7(a) loans regardless of the remaining term.

The penalties only apply if you voluntarily prepay more than 25% of the outstanding loan balance in that year. So you can make smaller extra payments with no penalty.

SBA 504 Loan Prepayment Penalties

For SBA 504 loans, there is a prepayment penalty that lasts for 10 years no matter the loan term. 504 loans are almost always for 20 or 25 year terms for real estate financing.

The 504 prepayment penalties decline each year as follows:

• Year 1: Maximum penalty – 100% of remaining interest
• Year 2: 90% of remaining interest
• Year 3: 80% of remaining interest
• Year 4: 70% of remaining interest
• Year 5: 60% of remaining interest
• Year 6: 50% of remaining interest
• Year 7: 40% of remaining interest
• Year 8: 30% of remaining interest
• Year 9: 20% of remaining interest
• Year 10: 10% of remaining interest

After year 10, there are no more prepayment penalties and you can pay off an SBA 504 loan. Partial prepayments are not allowed – you can only prepay an SBA 504 loan in full.

How To Calculate SBA Prepayment Penalties

Figuring out how much the actual prepayment penalty fees will be takes a few steps. Here is how to calculate SBA loan prepayment penalties:

1. Determine the prepayment year

First figure out which year after getting the loan it is to see what percentage applies.

2. Calculate the remaining interest

Figure out the current outstanding principal balance, then multiply this by the interest rate to get the annual interest amount.

3. Apply penalty percentage

Take the full remaining interest amount and multiply it by the correct penalty percentage for that year.

4. Compare 25% threshold (7(a) only)

For SBA 7(a) loans, see if the proposed prepayment exceeds 25% of the loan balance. If not, there is no penalty.

Let’s look at a quick example:

• Original SBA 7(a) Loan Amount: $500,000
• Current Balance in Year 2: $450,000
• Interest Rate: 6%
• Proposed Prepayment: $200,000 (more than 25% of balance)

1. It is the 2nd year of the loan
2. $450,000 balance x 6% interest rate = $27,000 in annual interest
3. 3% penalty in year 2
4. $27,000 annual interest x 3% = $810 prepayment penalty

So in this case the penalty would be $810 to prepay $200,000 in year 2 of the loan.

Tips For Avoiding SBA Prepayment Penalties

If you want to avoid any prepayment penalties, here are some strategies:

• Take the maximum loan term to push the penalty period further out
• Wait to prepay until after the 3 year (7(a)) or 10 year (504) penalty period
• Pay down less than 25% of an SBA 7(a) loan each year
• Refinance with a non-SBA lender after the penalty period
• Request a waiver of the penalty from the lender

Getting the loan term extended or waiting until after the penalty period expires are the surest ways to avoid fees.

Is It Ever Worth Paying The SBA Prepayment Penalty?

In some cases it can be worth it to just pay the penalty and prepay your SBA loan early. Here are some examples:

You can get much better loan terms: If interest rates drop you may want to refinance and get a dramatically lower rate, even after paying the penalty.

You are selling the business assets: If you are selling the commercial real estate or business that you got the SBA loan for, having the loan paid off can help finalize the sale.

Your business had extra income: If you have excess cash flow in a certain year, it may make sense to prepay a large lump sum and pay the relatively small penalty.

Cash flow issues: Paying off the loan frees up monthly cash that you need for other expenses or to get through a slow period.

The key is to run the numbers and see if the prepayment penalty is less than the interest you save by paying early.

You can also negotiate with the lender – sometimes they may waive part or all of the prepayment penalty if you ask.

The Bottom Line

Paying off an SBA loan early can sometimes result in prepayment penalties that should factor into your decision. SBA 7(a) loans have penalties for the first 3 years, while SBA 504 loans have declining penalties for 10 years.

To avoid surprises, be sure you understand the prepayment penalty structures before taking out an SBA loan. If you do face a penalty, calculate the exact amount and weigh if the benefits of prepaying still make it worthwhile. With some planning, you can minimize or eliminate prepayment penalties on your SBA loan.