How SBA Variable Interest Rates Work

In this article, you’ll learn:

The difference between variable interest rate loans and fixed interest rate loans
What the SBA 7(a) loan program is
How SBA variable interest rates work
How to qualify for an SBA loan
Pros and cons of an SBA variable interest rate loan

So, you’re thinking about applying for a U.S. Small Business Administration (SBA) loan. That’s great news! The SBA, which was created in 1953, is a federal agency that has helped countless small business owners secure funding – the Paycheck Protection Program (PPP), for example, gave more than $780 billion in forgivable loans to more than 10.7 million borrowers.

The SBA offers variable interest rate loans and fixed interest rate loans – we’re going to start by comparing the two types of loans. After understanding the differences, you will learn whether or not an SBA variable interest rate loan is right for your small business.

Variable Interest Rate Loans vs. Fixed Interest Rate Loans

A variable interest rate loan is a loan in which, as the name suggests, the interest rate varies over time. The rate is linked to a benchmark, such as the prime rate – more on this in a bit. Your loan payments decrease if the benchmark decreases and increase if the benchmark increases.

The interest rate on a fixed interest rate loan stays the same for the life of the loan, regardless of any benchmarks. With this type of loan, you know your monthly payments ahead of time.

So, which type of loan is better for you? As with so many things in business, the answer is “it depends.”

Do you expect market interest rates to soar over the next year? In this case, you may want to take out a fixed interest rate loan. If you expect a drop in rates, on the other hand, a variable interest rate loan may be right for you.

Here’s another consideration: your ability to deal with uncertainty. A fixed interest rate loan might make sense with its predictable payments for a small business owner who values certainty.

What is the SBA 7(a) Loan Program?

The SBA 7(a) loan program is the most popular type of financing provided by the federal agency. With this program, a small business owner can access up to $5 million in financing. The SBA guarantees up to 85% of the loan, depending on how much the small business owner borrows.

A small business owner can use an SBA 7(a) loan for commercial real estate, short- and long-term working capital, refinancing current business debt, and purchasing furniture, fixtures, and supplies. The maximum maturities for SBA loans are 25 years for real estate, 10 years for equipment, and 10 years for a working capital or inventory loan. Here is some more info on maturity terms.

How SBA Variable Interest Rates Work

If you decide to get an SBA loan, you negotiate the interest rate with the SBA lender. With that being said, there are SBA maximum interest rates, which are pegged to the prime rate, the LIBOR rate, or an optional peg rate.

What is the Prime Rate?

The prime rate is the interest rate large corporations pay to commercial banks – it is determined by the federal funds rate.

What is the LIBOR Rate?

The London Interbank Offered Rate (LIBOR) rate is the interest rate at which big global banks make short-term loans with one another. The Waterfall Methodology, a standardized, transaction-based, data-driven, layered method, is used to calculate the LIBOR rate.

What is the SBA Optional Peg Rate?

The SBA optional peg rate is based on what the federal government pays for loans with similar maturities – it is calculated each quarter, and you can find it in the Federal Register.

How are SBA Variable Interest Rates Calculated?

Your SBA loan interest rate is pegged to one of the three rates mentioned in the previous sections – the lender adds a percentage to the base rate. A higher loan amount is currently correlated with a lower spread (the amount added to the base rate). With maturity, it’s the other way around; a longer maturity is currently correlated with a higher spread.

How to Qualify for an SBA Loan

To qualify for an SBA loan, you need to meet several eligibility requirements. Here are a few of them:

Be a for-profit organization, not a non-profit organization
Have equity in the business
Operate in the United States or its possessions

With other types of financing, such as a term loan from an online lender, the loan application process is simple, and you get a decision in less than a week. But with an SBA loan, you have to provide several documents and fill out several forms – and you may have to wait over a month to find out if you qualify for financing. Reviewing the eligibility requirements before you get started lowers your chances of wasting time.

With all that being said, many small businesses meet the eligibility requirements. If you are one of them, you can move on to your loan application. Here’s a checklist of what you need to submit to the SBA. Some documents can be easily gathered, such as personal and business federal income tax returns, business financial statements, and personal resumes for each principal. With other pieces of the puzzle, you may want to get help from a qualified professional. For example, you must explain why you need the SBA loan and how you expect the financing to help your business. A Certified Public Accountant (CPA) may be able to provide valuable input that increases your chances of securing funding.

You can get an SBA loan through a traditional bank or online lender. With any potential lender, it’s essential to ask how much experience they have processing SBA loans; the process isn’t easy in the best-case scenario – so you don’t want to make things harder than necessary. Biz2Credit has experience connecting small business owners with SBA funders, making the process as easy and convenient as possible.

meta description: With interest rates rising, it is more important than ever before to understand how variable interest rates work. Learn about how variable interest rates work for SBA loans in particular with our guide!

Nick Vasco

Pros and Cons of an SBA Variable Interest Rate Loan

Here are some of the pros and cons of getting an SBA variable interest rate loan – some of these apply to SBA loans in general.

Pros

Here are a few pros of getting an SBA variable rate loan:

Get a below-market interest rate. Since the SBA guarantees a large portion of the loan (up to 85%), lenders face reduced risk when offering this type of business loan – as a result, they are comfortable offering favorable loan terms.
Use the loan for a variety of business purposes. With some types of loans, such as an equipment loan, you can only use the financing in specific ways. This isn’t the case with an SBA loan – you can use it for various short- and long-term business needs. For example, you can use an SBA loan to alleviate an expected short-term dip in cash flow. Or you could use it to purchase a plot of land to build a new facility.
Make a lower down payment. You typically don’t have to make a sizeable down payment to get an SBA loan, allowing you to secure financing if you want to preserve cash for other purposes. If you have too much cash in your business bank account, here are a few ways to invest your small business’s extra cash.

Cons

Here are a few cons of getting an SBA variable rate loan:

Face a challenging process. We touched on it earlier, but it’s worth repeating: the process of getting an SBA loan has a high chance of testing your patience. If you have the time to put your application together and the time to wait for a decision, an SBA loan might be the right loan option for your business. But what if you have a setback and don’t have enough cash to pay your staff next week? In this case, you might want to use a different small business funding option.
Risk paying a higher interest rate. The federal funds rate was increased to a range of 0.75%-1% in May, and the rate is projected to be 2.75%-3% by the end of the year. Since other interest rates respond to the federal funds rate, you may have to pay a higher interest rate in a few months if you get an SBA variable interest rate loan. With a fixed-rate loan, on the other hand, you would lock in the interest rate on Day 1.
Need a strong business. You may have difficulty qualifying for an SBA loan if you have a sub-optimal credit score and your business doesn’t have a solid track record. With that being said, it may be easier to get an SBA variable interest rate loan than a term loan from a financial institution.

The Bottom Line

For small business owners who meet the eligibility requirements, an SBA variable interest rate loan is an excellent small business financing option – particularly if they satisfy the following conditions:

Have the time to apply.
Have the ability to wait for a decision.
Willing to accept the uncertainty that accompanies the variable interest rate.

Before applying for an SBA variable interest rate loan, make sure you are fully aware of how the interest rate will be calculated. The stakes are high, particularly for a longer-term small business loan for a substantial amount of money. If you take out a five-year loan, for example, the repayment terms may look a lot different towards the end of the life of the loan.

Biz2Credit has experience helping small business owners get SBA funding, including Ajita Mohan, who has a counseling service. Mohan said, “I submitted paperwork, and was helped by their team in accessing lenders. It was pretty painless.”

Learn more about how Biz2Credit can help you fund what’s next for your small business.