The discount rates determine what percentage of the collateral your bank lends. Read on to learn how to get different plans – and when you should.
Owning and running a business requires a lot of specialized local knowledge. You have to know which employees do not understand each other and should not work together. How to Find Good Articles on SBA Loans. How to get the best deal on inventory. What are the best prices for all your products.
One of the things you don’t need to know is the discount rates for SBA collateral or why they matter. It might still be worth studying them though. Read on to find out.
Overview: What is the discount rate?
The discount rate is applied to collateral that you acquire with a loan. The SBA prefers loans over $350,000 to be fully secured. That is, if the discounted value of the collateral is less than the total loan amount, the bank must seek additional collateral. This could be a secondary lien on your home or the titles on vehicles that you own outright.
The various SBA rebate rates can be found in the SBA SOP (Standard Operating Procedures). Here are the current discount rates for the SBA’s main product 7(a):
Why do different types of collateral have different discount rates?
There are several factors that go into the SBA’s discount rates, including the age of the collateral, ease of resale, and the preservation of value of the collateral.
Each factor makes intuitive sense. You should discount used equipment more than new as it is difficult to know exactly how much wear and tear there is on used equipment. Likewise, you would discount inventory more than real estate since many types of inventory spoil or go out of style quickly.
How the discount rate affects your loan
Let’s take a look at a few different SBA loan examples and see how the discount factor would affect each.
1. Buying real estate
When I underwrote SBA loans, the vast majority were done to get better discount rates or loan terms than the borrower could get with a traditional loan.
A conventional real estate loan typically has a term of 10 years with an amortization of 25 years. That means you make payments as if the loan is due in 25 years, and then owe a large balloon payment after 10 years. In this type of loan, the collateral is discounted by 25% to 30% depending on the borrower’s credit rating. You can shop, but that’s as good as it gets.
If you use an SBA 7(a) loan, the lower appraised or selling price is discounted by 15%. That means you’ll have to meet the 15% either through additional collateral or, more likely, cash. This is far better than the traditional 25%-30%. A $1 million loan can leave an additional $150,000 in your bank account.
The other option is an SBA 504 loan. The 504 product works differently than the 7(a) product. With a 7(a) loan, the bank lends you the money and the government guarantees 75%. With a 504 loan, you actually have two loans: one from a traditional bank and one from a nonprofit organization guaranteed by the government. The traditional note takes the first position in security, which means that if you default, the regular bank will be paid first.
SBA 504 loans lend up to 90% of the collateral value if your business has a good credit history.
As you may have noticed in the table above, there are three different ways to reduce gear stats. Brand new equipment is discounted by 25% and used equipment is discounted based on value. If you subtract the net book value (cost – depreciation) from the balance sheet, you get a discount of 50%. If you get a proper dissolution value (OLV) from an appraisal, you only have to deduct 20% of this. These estimates range from $250 to $3,000 depending on the type of gear and number of items.
There is a 25% discount on new devices as the resale value never equals the sticker price. Fair liquidation value, on the other hand, is the price that a professional appraiser believes you could sell the equipment quickly, so it’s less discounted. That doesn’t mean you should commission a new device appraisal to get a better discount rate – the OLV is likely to be significantly lower than new.
In my experience, OLV is used when a borrower is struggling to make a loan work and needs to get a few extra bucks off the value of the equipment they have. Otherwise we go with half the book value and save the money for the report.
Traditional loans have similar interest rates. Some large banks have specialized departments that work with different types of equipment and you may have better options there. In many cases, working with a leasing company is the best option. You start with far fewer down payments, but the lender makes up for it with higher payments.
3. Working Capital and Trading Assets
Loans secured by trading assets (receivables and inventories) are typically used for working capital. The SBA discounts the value of trading assets by 90% when used as collateral for other types of loans.
ARs are notoriously unreliable when it comes to holding value. Most companies don’t have a great sales contract, and most customers are incredibly difficult to contact for collections.
Inventory can be even worse. A bank I once worked for was stuck with hundreds of niche medical devices with no way to sell them. Eventually we put them on eBay for a fraction of what they were supposed to be a deposit on.
The SBA prides itself on being a self-sufficient organization. It claims it can back the guarantees it pays out to banks with the guarantee fee it charges for each loan. In order to be able to do this, extensive collateral coverage with reliable collateral is required.
The only way to avoid the 90% rebate on trading assets with an SBA loan is with an SBA express loan or one of the SBA loan products.
SBA Express Loans are only 50% guaranteed and require the lender to apply their own underwriting standards. You should only apply for an SBA express loan if you really cannot get conventional financing. Traditional financing is likely to be cheaper.
Likewise, the SBA loan products are not intended to be evergreen products. They exist to be used by startup companies or companies in a difficult phase. If you can qualify for a traditional line of credit, it’s probably cheaper.
How do you weight the discount rate?
There are many factors to consider when looking for financing. What are you planning to do with the loan funds? What is the credit period? What is the interest rate? What is the discount rate for collateral? It all comes down to money.
If you can secure a lower down payment with an SBA loan, but at the cost of higher fees and a higher interest rate, you need to think twice about whether it’s worth it. If you’re growing fast and you can easily make those payments in a few years, but you need the money now, it makes sense. If you’re awash with cash but want a lower payment, go for the other option.