Because SBA 504 loans act differently than standard commercial loans, there is a process, and sometimes a cost, in paying off an SBA 504 loan early. Today’s blog discusses the process, timing, and costs for a borrower wishing to pay off a 504 loan before it matures.
Before I talk about the process of paying off an SBA 504 early it’s important to describe how a 504 loan is funded. The funds for commercial loans (as well as other economic development loans through SEDA-COG) come from a specific loan account. As payments come in the principal goes back in the account to be lent to someone else. However, in the case of the 504 program, the funds do not come from an account at the SBA. The funds come from a bond offering backed by the SBA that the loan is part of. Those bonds are sold to investors looking for a long-term, low-risk investment. The investors get an interest payment every 6 months and their principal back at the end of the bond.
Since the bondholders are guaranteed interest payments and their principal back the SBA puts a prepayment penalty on 504 loans through the first 10 years of a 20-year loan and through the first 5 years of a 10-year loan so there are enough funds available to pay the interest back to the investors for the remaining term of the bond. Click here for more information on the SBA 504 prepayment penalty.
So what is the process for paying an SBA 504 loan off early? The procedure for paying off SBA 504 loans early is a formal process. Only on one day per month (the 3rd Thursday) can your SBA 504 loan technically be paid in full. Typically, Wells Fargo (the servicing agent for 504 loans) will tell us the final payment amount we need from the borrower on the 6th business day of the month before the date on which they are scheduled to make the payment. The payoff needs to be scheduled by the 6th business day of the month for payoff to be made on the 3rd Thursday of the month. The reason for this set of procedures is that they need to have everything prepared for that loan to be taken out of the bond pool for the 1st of the following month.
Prior to the 6th business day of the month we can provide a working estimate of the payoff amount. To be timely and to make sure the borrower has the information they need to make an informed decision, we ask that they call us for an estimate on the early payoff of the loan before they commit to a prepayment.
Depending on when the borrower decides to prepay, they can end up with expenses in addition to any prepayment penalty costs. Monthly payments accrue to make a semi-annual debenture payment to the investors who funded the loan. The borrower is obligated to make the monthly payments up through the next semi-annual debenture payment date. Consequently, we typically suggest that the borrower holds off on making their prepayment until just before one of their semi-annual dates, so that they do not pay additional interest expenses.
What are the semi-annual dates for SBA 504 loans? The dates correspond to when the bond was initially funded. For example, if the loan is part of a bond that was sold in March, the semi-annual months would be March and September. In this case, the best time to pay-off the loan would be on the 3rd Thursday of February or August as SBA 504 loans must be paid until the next semi-annual due date (full principal, interest and fees excluding the CDC monthly fee). Wire funds may be sent after the actual is available. However, funds must be received by no later than mid-day on the 3rd Thursday.
Since paying off an SBA 504 loan is different than commercial loans, the best advice is to contact the CDC who provided the loan well ahead of any scheduled payoff so as to avoid any delays in the settlement and possibly any additional costs.