The SBA 504 pre-payment penalties are often misunderstood by both borrowers and industry professionals. A question we often get is: “Are there pre-payment penalties with SBA 504 Loans”? The answer is yes, but it’s not as bad as you might think.
The pre-payment penalty declines in an accelerated fashion over the first 10-years, calculated semi-annually, and is eliminated in year eleven. And because there are lower interest rates associated with 504 Loans, the 504 is oftentimes the more affordable choice.
Can I Pay Off My SBA 504 Loan Early? And Is There a Pre-Payment Penalty?
Yes and yes. However, typically the rate on your first mortgage loan is adjustable and higher than the 504 rate, so it’s to your advantage to make additional payments on the first mortgage loan rather than pay off the 504 loan.
If you choose to pay off your 504 Loan early, the duration of the pre-payment penalty depends on the term of the loan. Typically, 504 Loans are either 20-year or 25-year loans, which carry a non-negotiable 10-year pre-payment penalty. Loans with a ten-year term can be repaid without penalty after five years. The amount of the penalty depends on the debenture rate assigned to your loan. Keep in mind, the debenture rate is lower than the effective (all-in) rate of the loan. For instance, if you have a 25-year term loan and your debenture rate was 5.82%, the payoff penalty for the first year would be 5.82% and decline by 10% every year afterward.
504 Pre-Payment: October 2023
| Year | Penalty |
| 1 | 5.82% |
| 2 | 5.238% |
| 3 | 4.656% |
| 4 | 4.074% |
| 5 | 3.492% |
| 6 | 2.910% |
| 7 | 2.328% |
| 8 | 1.746% |
| 9 | 1.164% |
| 10 | 0.582% |
So, let’s say you have a 25-year term loan, and you’re thinking about paying off in the fifth year. Pre-payment penalties decrease annually. Thus, if your loan was to be paid off at the five-year mark, you would pay the balance due on the loan, plus 3.246% of the remaining balance as a pre-payment penalty. In addition to the prepayment penalty, interest and servicing fees (not the CDC servicing fee), through the next semi-annual debenture date are included in the payoff. The debenture dates are based on the funding date of your loan. Our Servicing Department can walk you through the details.
What’s a Debenture Rate?
As noted, the SBA 504 debenture rate is considerably less than the interest rate. This is important…and the debenture rate is not generally discussed as much.
SBA 504 loans are bundled as debentures and sold to government and institutional investors to support the 504 Loan Program. The debenture rate is the rate paid to the investors semi-annually. Your early prepayment represents a risk to those investors and the prepayment penalty partially makes up for their loss.
The debenture rate, like the loan’s interest rate, is based on the treasury rate plus the “spread,” or percentage added to that rate. The debenture rate is different from (and lower than) the interest rate because it is calculated semimonthly and does not take fees and closing costs into consideration.
Read about other Frequently Asked Questions.
The amount of the penalty depends on the debenture rate assigned to the loan. Keep in mind, the debenture rate is lower than the effective (all-in) rate of the loan.
Pre-Payment Penalties in Summary
Despite the myths, SBA 504 pre-payment penalties are not as bad as they seem. Here’s the breakdown:
- For 20- and 25-year SBA 504 Loans, the pre-payment penalty declines in an accelerated fashion over the first 10 years and is eliminated in year eleven. For a 10-year term, the same principles apply…the penalty declines in an accelerated fashion over five years and is eliminated in year six.
- The pre-payment penalty is calculated based on the loan debenture rate, which is lower than the effective, or “all-in” rate
- The maximum pre-payment penalty would be the full debenture rate of the principal remaining on the 504 Loan. This amount declines by 10% each year, so five years in the pre-payment penalty would be cut in half.
- There is no pre-payment penalty during the second half of the loan’s term.
Want to Learn More?
Keep in mind, we work in conjunction with local banks…not in competition with them.
Why Growth Corp? We know small business. It’s our passion. We are proud to have helped thousands of businesses facilitate expansion. As the largest 504 Lender in Illinois, we have dedicated ourselves to making the 504 Loan Program as efficient and seamless as possible. If you want to learn more, we would be happy to meet with you. Just give us a call at 877-BEST 504 or contact any member of our Lending Team.