Small Business Loans

Paying Off An SBA Loan Early: Should You Do It?

Updated: September 11th, 2020

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Let’s say you’ve scored yourself one of the most coveted types of financing for a small business: an SBA 7(a) loan. No doubt you were drawn in by the generous maturity that stretches your payments over as long as a decade or even 25 years for real estate loans. You’re not alone, as the lengthy repayment period is one of the most attractive features of the product for business owners. But maybe you realize that you took out more than you actually need. Now, you are wondering if it would hurt to get rid of the interest payments sooner than later. 

If you decide on paying off an SBA loan early – whether it’s to free up more cash flow for the slow months or for some other reason – it affects not only you but the bank or alternative lender, too. They were betting on those interest payments for the life of the loan. And while SBA-backed loans are unique in many ways, they are just like many other loans available in the market. What we mean is that they can carry a penalty for early repayment. Whether or not you should pay off an SBA loan early ultimately comes down to the math. 

Mechanics of the SBA loan 

If you’re considering knocking out your debt early, you’ll want to familiarize yourself with the loan’s features. In the case of the SBA loan, this means getting to know amortization. This is a fancy way of describing the way the loan is spread out over the term. Most SBA loans are amortized. 

Amortization involves separating the amounts that will be directed toward principal and the part that goes toward interest each month. It also includes a snapshot of how the loan amount balance changes with each payment. With each payment you make, a certain amount goes toward the principal and another part goes toward interest. Early in the loan, a higher amount of the payment will be directed toward interest. So, it is understandable that you might want to pay off your SBA loan early. But doing so can cost you. 

SBA loan early payoff penalty 

Whether or not you should be paying off an SBA loan early will depend largely on if you would be stuck paying a penalty and how large that penalty is. If you can pay the penalty and still end up saving money on interest, it could justify the prepayment. 

Not all loans penalize you for prepaying a loan. But, the SBA’s widely used 7(a) program is in the camp that does. For loans with a maturity of at least 15 years, the SBA tacks on fees when a business owner “voluntarily prepays” more than one-quarter of the outstanding balance of a loan. 

How much is the penalty for paying off an SBA loan early?

This SBA loan early payoff penalty is only applied if you decide to pay off the loan within the first three years of receiving the loan proceeds. So basically, if you can afford to hold off from paying off the SBA loan early (aka for three years), you can avoid the penalties. Also, if the loan maturity is less than 15 years, you’re off the hook. Otherwise, the fee scale is as follows from the date you receive the funds —

  • Year one =  5% of the total prepayment amount
  • Year two = 3% of the total prepayment amount 
  • Year three = 1% of the total prepayment amount 

Exceptions to the SBA loan early payoff penalty

The SBA also states that for loans sold on the secondary market, business owners can prepay as much as 20% of the balance at any point in the loan term without facing a penalty. If you plan on paying more than 20%, you must: 

  • Provide the lender with three weeks worth of written notice or you’ll have to pay 21 days worth of interest. 
  • Make the prepayment within 30 days of the notice date or you’ll have to start the process over again. 

Here is where the math comes in. Using an amortization chart or table, calculate the amount of money that you’d save on interest by paying off the loan early. Next, determine any fees that might be charged by the lender for doing so. If the amount you’d save in interest surpasses any fees that would be charged, it could make sense to prepay. On the other hand, if the fees offset any savings you would reap, you might want to reconsider prepaying the loan. Keep in mind that if you’re close to the end of your loan term anyway, it may not provide much benefit. 

How paying off an SBA loan early affects cash flow 

If you are in a position to have enough cash flow to pay off an SBA loan early, you are fortunate. But you should also be aware of all of the potential consequences. For instance, consider what other obligations that you have and make sure that you will be able to meet them after shoveling off the loan. The year 2020 has proven that unexpected things can happen. So, make sure that you can do without that cash in a pinch. 

Also, consider what paying off an SBA loan early means for tax season. One positive feature about the interest that’s been accruing on your loan is that it’s fully deductible on your business taxes. This is an item that you are in jeopardy of losing once you prepay. We suggest you ask your accountant about your situation. 

Getting the green light to prepay 

A scenario that would warrant paying off an SBA loan early would ironically be so that you could inherit more debt but at more attractive terms. A lender might not be inclined to approve your credit application if you’re already paying off another loan. This is especially true if your debt-to-equity ratio, which is a reflection of the amount of debt you’re using to operate your business, is nearing an unmanageable ratio. So if you’re trying to capitalize on the current low interest rate environment or just found better terms elsewhere, it could be your cue to pay off an SBA loan early. 

Another thing to consider is that not all lenders penalize you like the SBA loan early payoff penalty does. At Funding Circle, you can apply for an SBA 7(a) loan for an amount up to $500,000 and not face any prepayment penalties if you’d like to pay off your loan early. You can apply for an SBA 7(a) loan now if you’re ready to grow your business.

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