One of the most common mortgage programs for small businesses also is one of the best. The U.S. Small Business Administration (SBA) and its well-known 7(a) loan can be a great way for small-business owners to get the capital they need to meet business goals and continue growing their companies.
The loans that most often languish in underwriting and closing for weeks or months are those that, from the beginning of the process, ride the line of eligibility or don’t quite fit in the credit box for a given SBA lender.
With long loan terms, competitive interest rates and high maximum loan amounts, the standard SBA 7(a) loan program has become extremely popular. Originators should know that these loans can be used for just about any business purpose. Because of this flexibility, they can be used in creative ways to meet the specific real estate financing needs of nearly any type of small-business owner.
Despite the benefits of SBA 7(a) loans, many small- business owners are turned off by these products because of the sheer amount of documentation required and the process delays that can often accompany a government-backed lending program. This doesn’t mean that it’s impossible to navigate this process quickly and efficiently, but there are challenges that must be addressed.
With the right knowledge ahead of time, many of the obstacles that slow down the loan evaluation and approval process can be avoided, or at least mitigated, resulting in a much smoother transaction and a faster time to close. To better educate commercial mortgage brokers who are interested in pursuing SBA loans as a product option, it is crucial to discuss common problems in the SBA loan process and look at solutions for how to avoid them.
Some of the most important aspects of the SBA loan process are eligibility and qualifications. The loans that most often languish in underwriting and closing for weeks or months are those that, from the beginning of the process, ride the line of eligibility or don’t quite fit in the credit box for a given SBA lender.
Of course, there are plenty of situations where a creative solution can help a loan request fit within a lender’s credit parameters. Often, however, a proposal that barely meets qualification criteria only begins to seem more of a risk as it moves down the pipeline. Therefore, at the beginning of the process, it is imperative to make sure that the transaction is SBA eligible and will in fact qualify for a loan.
One of the most important issues to note with respect to loan qualification includes cash flow. If a business does not show enough earnings on its most recent tax forms to cover the proposed loan payments, it is unlikely to qualify for an SBA loan. If cash flow is tight during the prescreening process, many times the picture gets even worse in underwriting. That is why it is vital to double check that numbers are calculated to match how an underwriter would analyze a transaction.
Another key qualification is collateral. The SBA requires that a borrower pledge any available collateral (including personal real estate) on any loan of $350,000 or more, until the loan is either fully secured or all available collateral has been pledged. It is important to make sure that borrowers understand this rule so that it does not arise later in the transaction and jeopardize the deal.
Many lenders will have their own policies on their ideal credit profile for a borrower. With respect to the SBA, however, it is important to make sure that a borrower has not previously defaulted on a government-backed loan, including student loans or prior SBA loans. A default on any of these types of debts will immediately prohibit a borrower from moving forward on a new SBA loan.
As a general rule, make sure to check the borrower’s credit score and their history of open and closed accounts. If the borrower has derogatory accounts or high balances, this will cause trouble during the approval process and should be addressed before the loan is sent to underwriting.
Liens and encumbrances
Loans often get held up by preexisting liens filed against a business that have yet to be removed and which will prevent an SBA lender from filing in the first position. It is imperative that an originator ask the borrower early in the process if they are aware of any tax liens against the business (or personally), as well as any other Uniform Commercial Code liens from prior lenders or contractors.
Although lenders tend to perform their own lien searches, these are often not done until later in the underwriting or closing phase of the transaction. Any information that can be obtained beforehand can be essential for faster funding.
With respect to real estate acquisitions and refinances, it is important to examine the preliminary title report provided by a title company. This will show whether there are any encumbrances or deed restrictions on the property that might cause trouble at closing, thereby preventing the borrower from acquiring a property with a clean title.
Another important aspect of SBA real estate lending is the property survey, which will show the legal boundaries of the property along with locations of easements, encroachments and other important information. Taking the time to confirm that a building is not encroaching on adjacent property lines, and verifying that the property being sold matches its legal description and survey, can save a lot of headaches down the road.
Agreements and forms
When it comes to purchase contracts, the most common problems arise when closing time frames are too short, purchase-price allocations between asset types are not clearly delineated, or the seller or borrower names are incorrect. It saves a lot of time in the long run to make sure these things are listed correctly in a purchase agreement and that the assets being purchased are clearly spelled out.
It is highly recommended to make sure that a purchase contract is agreed upon and fully executed before a loan goes into underwriting. Submitting a loan with only a signed letter of intent can often waste a lot of time if a seller winds up not signing the contract after a deal has been underwritten and approved.
Filling out SBA and lender forms can be a hassle, but these steps typically do not significantly slow down a transaction. What does cause a deal to bog down is when a borrower cannot produce up-to-date financial information — such as profit-and-loss statements, balance sheets, debt schedules, and reports on accounts receivable and payable.
The SBA requires that financial statements be no more than 120 days old. If a borrower is slow to produce timely financial statements, then their documents can go stale, so to speak, before a transaction closes. This will result in serious delays. Lastly, borrowers will need items such as legal-entity documents, business insurance policies, equipment lists and more, to close their SBA loan. The sooner these types of items are in place, the better.
Other potential problems
Environmental issues arise on occasion, and they can derail or slow down a transaction. These types of properties require an environmental investigation. Some of the most common property types that require extended environmental reports are gas stations, auto-related businesses, laundromats, car washes and some industrial buildings.
Since these property types almost always require at least a Phase I Environmental Site Assessment report, asking a seller or borrower if they have a prior Phase I report (or a Phase II report for higher-risk properties) can save precious time. Additionally, it is important to note that acquisitions or refinances of older daycare centers require lead-risk assessments of paint and water.
Another problem that slows down the loan process is when a borrower secures additional credit while in the process of obtaining an SBA loan. Making sure that borrowers understand that it can take 60 to 90 days or more to close the loan will help them to plan ahead so they aren’t forced to take on additional debt during that time frame.
Too many times borrowers make it all the way through underwriting before they disclose that they are subject to some form of pending legal action. Whether it is a divorce or some other legal action against the business owner, the business entity or an affiliate, these proceedings must be settled before a lender can close on an SBA transaction.
When a borrower’s business leases space, it is important to make sure that the lease is SBA compliant, and that the landlord is willing to sign a consent or waiver form on behalf of the lender. Lease terms (the original term plus any options to extend) must be equal to the length of the loan term. If the lease term is shorter than the loan term or if the landlord is hesitant to sign a consent form, then it is important to get these types of lease negotiations started early in the process since these issues can significantly delay a closing.
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Although the list of issues above is by no means comprehensive, it’s clear that there are many factors to consider in the beginning stages of an SBA loan to make the transaction as efficient as possible. Understanding these nuances can not only make the loan originator look like a hero but can often be the difference between a 35-day closing and a 90-day ordeal. ●