Understanding SBA 504 Effective Rate Calculations

While the low fixed rate is one of the most appealing features of the 504 Loan Program, understanding the Effective Rate which measures it can be a challenge.

Steve Van Order, the fiscal agent responsible for managing the purchase and sale of 504 debentures recalls, “In the winter of 2001, one of the first things I did before interviewing for the Fiscal Agent position was to try to understand the various interest rates in the 504 program. I searched out a debenture rate and various fees for a given offering, easily finding the data on the National Association of Development Companies (NADCO) website. I simply added the debenture rate plus the CDC fee plus the CSA fee plus the borrower fee and, voila, I figured I had calculated my first effective rate – what I guessed was a rate similar to a loan APR or all-in rate. But was I wrong! The rate I calculated was below the reported effective rate.”

He reports there are three key points to remember in understanding the table and the stated effective rates as published on the NADCO Website:

• The debenture pays semiannually, but the note pays monthly. The semiannual payment feature of the debenture means the 504 debenture or bond looks similar to other government market bonds such as U.S. Treasury notes. It is an important feature that helped attract buyers for over $23 billion issued since 1986. It means, however, the semiannual-pay debenture rate must be converted to an equivalent monthly-pay note rate for borrowers. Conversion to the monthly-pay note rate is a straightforward calculation.

• Ongoing program fees (i.e. borrower, CDC and CSA fees) are re-calculated every five years, so do not amortize at the monthly speed of the loan principal balance. That means simply adding those fees together understates the borrower fees. The effective rate calculation was designed to take into account the unique five-year reset of ongoing fees.

• An effective rate does not include the impact of upfront borrower fees . That is why an effective rate is not technically an APR or all-in rate.

For more information on current or past effective rates, please visit the NADCO website at: www.nadco.org