When it comes to SBA 7a loans with a maturity period of 15 years or more, there are certain prepayment penalties that borrowers need to consider. The vast majority of all 7a SBA loans are for less than 15 years — typically 10 years – so most SBA loans do not have prepayment penalties. For those loans with terms of 15 years or more, the SBA prepayment penalties are triggered when the borrower voluntarily pays off 25 percent or more of the outstanding loan balance within the first three years following the initial disbursement of the SBA loan funds.
The prepayment fees associated with these penalties are structured as follows:
1. In the first year after the disbursement, a fee of 5 percent of the prepayment amount applies.
2. In the second year after the disbursement, a fee of 3 percent of the prepayment amount applies.
3. In the third year after the disbursement, a fee of 1 percent of the prepayment amount applies.
It is important to note that currently, 7a SBA loans typically have a term of 10 years for non-real estate loans and 25 years for loans involving real estate. However, in some cases where both real estate and non-real estate components are involved, the loan term may deviate from the standard 10 or 25 years.
Note that the word “voluntary” above regarding prepayment. Contractual monthly principal payments are not subject to prepayment since these payments are not actual prepayments.
Example of prepayment penalty
Assuming a $1,000,000 loan, the prepayment penalty for a voluntary prepayment of $400,000 would vary from $20,000 if done in the first year of the loan down to $0 if prepaid in year 4 or later:
| Year of Prepayment | Prepayment Fee | Prepayment Amount | Prepayment Penalty |
|---|---|---|---|
| Year 1 | 5% | $400,000 | $20,000 |
| Year 2 | 3% | $400,000 | $12,000 |
| Year 3 | 1% | $400,000 | $4,000 |
| Year 4+ | 0 | $400,000 | $0 |
Regardless of the prepayment penalty, the interest savings from prepayment almost always makes it more attractive to prepay versus stay on a standard payment schedule. For example, we know from our handy SBA loan payment calculator that the SBA loan payments and interest for an 8%, $1,000,000 loan with a 25-year term would result in $1,315,449 in interest expense over 25 years. Assuming a $400,000 prepayment the very first day of the loan would save $32,000 ($400,000 x 8%) in interest expense per year but cost $20,000 only once. We advise speaking with you financial team before making a large debt prepayment as many other factors come into play (e.g., a need for a minimum liquidity levels, other potential returns on idle cash), but suffice to say here paying a prepayment penalty is financially prudent in many situations.
FAQs related to SBA loan prepayment penalties
Are prepayment penalties applicable to all SBA 7(a) loans?
Yes, prepayment penalties only apply to SBA 7(a) loans with a maturity period of 15 years or longer. However, most SBA loans are for 10 years.
Are prepayment penalties waived in the event of involuntary prepayment?
Yes, prepayment penalties may be waived if the SBA lender believes the prepayment is involuntary. The most common case of involuntary prepayment is the death of the borrower. For involuntary prepayments, the SBA lender must petition the SBA on behalf of the borrower with the lender’s supporting analysis before a penalty waiver is granted.
Do prepayment penalties apply to partial prepayments?
Yes, prepayment penalties apply to any voluntary prepayment that exceeds 25 percent of the outstanding loan balance within the first three years, regardless of whether it is a full or partial prepayment.
Can prepayment penalties be negotiated or waived?
Prepayment penalties are typically standard terms outlined in the loan agreement mandated by the SBA, and they are not subject to negotiation or waiver unless explicitly stated otherwise in the loan terms.
Can I refinance my current SBA loan with a lower cost SBA loan if rates decline?
No, the SBA does not allow borrowers to use the proceeds from a new SBA loan to repay an existing SBA loan. Keep in mind that most SBA loans are variable-rate loans, so if rates decline, variable-rate borrowers will see lower interest costs.
Are prepayment penalties tax deductible?
Yes, prepayment penalties are considered interest expense in the eyes of the Internal Revenue Service, but please consult with your tax professional regarding our ever-changing tax laws so there are no surprises.