Should You Repay an SBA Loan Early?

If you have extra cash lying around, paying off your debt quickly seems like an obvious choice. But if you have one SBA Loanthe decision may not be so easy. Many SBA loans have prepayment penalties, meaning paying off early can come with an additional cost that cuts into your potential savings.

Both SBA 7(a) and 504 loans have prepayment penalties. On the other hand, SBA microloans and disaster loans do not have prepayment penalties.

a Prepayment penalty Lenders charge a fee when you pay off your loan before the maturity date. When you pay early, lenders lose out on the interest they expect to receive on your loan. Prepayment penalties are designed to help recover some of this loss.

The US Small Business Administration charges a prepayment penalty – called a “subsidy recovery fee.” SBA 7(a) Loans with repayment terms of 15 years or more.

You will only owe this fee If you pay off more than 25% of your balance in a single year during the first three years after receiving the funds⁽⁰⁾

Here’s how the fee works:

• First year: 5% of the total amount you prepaid.

• Second year: 3% of the total amount you prepaid.

• Third year: 1% of the total amount you prepaid.

After the third year, you can repay your loan early without any fees.

Short-term SBA loans—those with terms of 14 years or less—have no prepayment penalties.

all SBA 504 Loan There are early penalties. The prepayment penalty applies only to the CDC portion of the loan. (As a reminder, 40% of SBA 504 loans are funded by a Certified Development Company, or CDC.)

For 20-year or 25-year 504 loans, the fee applies during the first 10 years of your loan. It starts high and decreases every year. In the first year, the prepayment penalty is equal to the interest rate on the CDC portion of the loan (called the debenture rate). After that, it decreases by 10% every year until it reaches zero after year 10.⁽⁰⁾

For 10-year 504 loans, the fees work the same way. This applies for the first five years of your loan. Again, in the first year, the cost is the same as the interest rate on the CDC loan. It then declines by 20% every year until it reaches zero after five years.

Unlike 7(a) loans, partial payments are not allowed on 504 loans. These loans can only be fully prepaid.

Although you may face early penalties, there are still benefits to paying off your SBA loan. Here are some to consider:

• Interest savings. If you pay off your SBA loan early, you can save more interest costs over the life of the loan. Let’s say, for example, you have a $10,000 SBA loan with a 10% interest rate and a 10-year term. If you pay off three years early, you can save about $7,000 in interest costs.

• Better cash flow. Without monthly loan payments, you’ll have more cash available to use for other business purposes.

• Peace of mind Eliminating debt can relieve stress and financial pressure – especially during seasonal or economic downturns.

There may also be drawbacks to paying off your SBA loan early, such as:

• Prepayment penalty. The added cost of prepayment penalties can eat into your potential interest savings from paying off early.

• Withdrawal of cash reserves. Using your cash reserves to pay off your debt can leave you short on working capital for day-to-day expenses, emergency expenses or new growth opportunities.

Follow these steps to determine if paying off your SBA loan early is right for you.

You’ll want to understand the terms of your loan and how potential payment penalties could affect you.

Let’s say, for example, you have an SBA 7(a) loan with a 15-year repayment term. If you want to repay more than 25% of your balance in any year during the first three years of the term, you will face a prepayment penalty.

If you’re not sure if your SBA loan has prepayment penalties, you can check your Loan agreement Or contact your lender for help.

Calculate how much interest you’ll save by paying off your loan early. You can use Nerd Vault SBA Loan Calculator To get an estimate yourself or approach your lender for an exact calculation.

Compare the potential savings to the cost of any payment penalties. If the predicted savings are greater than the penalty, it may make sense to pay off sooner. If the savings are only slightly higher, it may make more sense to wait.

Saving on interest isn’t the only factor when deciding whether to pay off your SBA loan early. Take a close look at your current cash flow and make sure you still have enough to cover your day-to-day expenses after making a big payment.

Also, consider whether the money could have a bigger impact elsewhere, such as reinvesting in your business, expanding operations or building an emergency fund. Maintaining healthy cash reserves allows you to remain flexible if you are faced with a slow period or unexpected expenses.

Before making a decision, it may be helpful to consult with a certified public accountant (CPA) or similar Financial advisor. These professionals can help you estimate potential savings and prepayment penalty costs. They can also assess cash flow and tax implications – and help you make the right steps for your financial situation.