By Jeff Rauth. Email Here or 248 885-8797. SBA Loan Officer at a Bank That Lends Nationally. 15 Years Commercial Real Estate Experience. Past Commercial Mortgage Broker.
A lot of borrowers (and bankers) are confused on how the SBA 504 pre payment is calculated. Many assume it’s a 10% step down (10% in year one, 9% in year two, 8%…) which is not the case. In fact, the SBA 504 pre pay is a lot cheaper than assumed.
The SBA 504 20-year fixed rate debenture, ie the loan that sits in second lien position, does have a 10-year pre pay however it is not on a simple step down. It is the debenture rate that sets the percentage or the amount of the pre pay – not an arbitrary rate of say 10%. Nor is it the bond rate associated with the debenture. It is based on the actual debenture rate, which typically has been about 160 bps less than the note rate to the Borrower.
SBA 504 Pre Payment Penalty Example
You close on a 20-year SBA 2nd mortgage debenture in the amount of $1,000,000 on July 1st 2013 at a debenture interest rate of 2.45%.
The 1st mortgage is held by your bank. We won’t discuss the 1st mortgage loan’s pre payment penalty in this example, as all lenders are different in how they handle it. But on all SBA 504 loans, the following rates and procedures are the same nationwide.
Let’s say that it is now June 2016 and you have outgrown your space and want to sell the property and move to a larger building.
The PPP amount is based on the debenture principal balance at the month prior to the anniversary date of the loan multiplied by the remaining debenture rate. For our example, we are going to conclude that the loan will be paid off by the anniversary date of the loan which is July 1, 2016.
In our example, the principal balance of our $1,000,000 debenture is now (3 years later) approximately $900,000. The PPP due would work like this:
The debenture interest rate determines the amount of the prepayment penalty. The PPP begins in year one. It is calculated by multiplying the debenture rate of interest by the principal balance on the debenture. The PPP then declines by 1/10th of the debenture rate annually on a 20-year debenture for the first 10 years. After that, the penalty is 0%:
Through June/2014 2.45% of $967,215
Through June/2015 2.21% of $933,035
Through June/2016 1.96% of $897,415
The PPP to pay off the loan in year 3 by the end of June is $17,589.
This is certainly not the 7% or $62,820 that the ‘SBA Myth’ might suggest!