* Full-term effective rate as November 2017 shown – includes all servicing fees.
Understanding the 504 Loan Effective Interest Rate
One of the most attractive features of a Small Business Administration (SBA) 504 loan is its low effective interest rate. However, understanding how this rate is calculated can be challenging.
In conventional lending, borrowers typically pay interest at a rate which the bank determines will cover the bank’s cost of funds; and when bank fees are included the resulting rate may be referred to as an annual percentage rate (APR) on the funds borrowed. Simply put, the APR covers the lender’s overhead costs of underwriting, payment processing and servicing, which are all internal functions. This is also known as an all-in rate as it is inclusive of the cost of the funds borrowed.
In the world of 504 loan interest, borrowers pay an “effective rate,” which is derived from a variety of both internal and external cost factors.
To begin, 504 loans are funded by the sale of 20-year bonds (debentures) which are pooled and sold on Wall Street each month and 10-year bonds (debentures) which are pooled and sold on Wall Street bi-monthly. The effective rate is comprised of the debenture rate, the note rate and ongoing carrying costs of the program as set by the SBA.
The debenture rate determines interest paid semi-annually to investors. The note rate is the monthly-pay equivalent of the debenture rate. Current ongoing carrying costs of the program (i.e., fees) are the CDC Servicing Fee, the Central Servicing Agent (CSA) fee and the ongoing Borrower Fee (paid annually).