Ask the Experts
Q: Can a 504 loan be prepaid, and what are the costs and procedures?
A: 504 loan can be prepaid in whole, but partial prepayment is not permitted due to the nature of the financing instrument used (bonds).
Costs
Because bonds are sold on the open market to fund the SBA 504 loans, there is a ten-year prepayment penalty associated with all 504 loans with a twenty-year term and a five-year prepayment penalty associated with all 504 loans with a ten-year term. Both are non-negotiable. The prepayment penalty goes to pay bond holder for the early redemption of the bond. A $1,000 non-refundable good faith deposit is required by the SBA for all prepayments.
Process
The small business must notify the Certified Development Company in writing at least thirty (30) days prior to the date on which it wishes to prepay the 504 loan. At this point, personnel in the servicing department will contact the borrower and will provide written instructions to complete the payoff.
The payoff amount consists of an amount equal to the outstanding principal balance of the 504 loan, less the $1,000 good faith deposit, plus interest accrued and unpaid thereon to the nearest semi-annual repurchase date (the bond associated with the 504 loan can only be repurchased by the SBA twice a year), plus the prepayment penalty and all SBA and CSA fees normally due and payable (that are also accrued and unpaid thereon to the nearest semi-annual repurchase date).
Prepayment penalty calculation
The prepayment is typically referred to as a 10-9-8-7-6-5-4-3-2-1 calculation when the term of the 504 loan is for 20 years. The equation for the penalty is:
Penalty = D (I x P), where
D = the remaining principal balance of the 504 loan.
I = the interest rate stated on the face of the Bond expressed in decimal points.
P = the factor set forth below for the applicable year
Year P
1 1.00
2 .90
3 .80
4 .70
5 .60
6 .50
7 .40
8 .30
9 .20
10 .10
11 and thereafter 0
There is no prepayment penalty associated with the 20-year 504 loan from year 11 and thereafter.
In the term of a 10 year 504 loan, the penalty factor is set forth below for the applicable year.
Year P
1 1.00
2 .80
3 .60
4 .40
5 .20
6 and thereafter 0
There is no a prepayment penalty associated with the 10-year 504 loan from year 6 and thereafter.
Note: Because the prepayment penalty is referred as the 10-9-8… penalty, it is commonly misunderstood that the penalty begins at 10%. Instead, for a 20-year loan, the penalty decreases from the bond rate by a tenth each year until the penalty expires in year 11. For a 10-year loan, it decreases from the bond rate by a twentieth each year until the penalty expires in year 6.
- With interest rates on the rise, does a borrower have to prepay his/her SBA 504 loan in order to refinance the participating 1 st mortgage loan?
- No. There are many options regarding refinancing the companion loan to the SBA 504 loan that would not involve the prepayment penalty. An example would be for the borrower to request a subordination of the SBA 504 loan to the new conventional loan. In some special cases, an assumption of the SBA 504 loan would be possible that would also eliminate the prepayment penalty; however, the assumption is available primary for properties being sold in liquidation.
Note: There are restrictions regarding refinance, subordination and assumption of the existing 504 loan, so if a borrower is considering any of these options, instead of a prepayment, please contact your local FFCFC representative for details.
For more information on prepaying an SBA 504 loan or refinancing the participating loan, please contact your local FFCFC representative or contact our corporate offices directly and ask for one of our servicing personnel and they would be happy to provide a prepayment estimate or answer any follow-up questions.
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