Can I use an SBA 7(a) loan to refinance high-interest business debt?

When your business faces a cash shortfall, you may frequently turn to the fastest source of money you can find. That often brings high interest, unreasonable repayment terms, and demands that endanger the company’s financial health. For the right loan package at the right price, look at refinancing with an SBA 7(a) loan.

Below, you’ll see why refinancing helps, and which types of debt qualify for it.

SBA loans are aimed at businesses that might not be eligible for traditional bank loans. The program also aims to support women-owned and minority-owned businesses.

Unreasonable Terms

The SBA 7(a) program can help refinance debt that has onerous terms or puts a company’s long-term health at risk.

Your lender’s criteria define what counts as unreasonable terms. While every business situation is different, unreasonable terms can include:

• Very high interest rates.
• A repayment schedule that makes it difficult to meet the loan. For example, weekly or even daily payments can make it difficult for some businesses to manage cash flow.
• A lender can also impose terms that make the overall business too risky.

These are just some of the situations that the SBA 7(a) loan is designed to help with.

Types of Debt Can Be Refinanced

While the refinancing rules for SBA loans aren’t as straightforward as for other purposes, a variety of types of debt can be refinanced in the right circumstances. Not every one of these rules will apply to your particular situation. So it’s important to keep in touch with your lender.

For 7(a) loans, the debt you want to refinance must have been for business purposes only.

Debt that the lender considers to have reasonable terms can’t be refinanced with an SBA 7(a) loan.

The refinancing can’t be used to shift any part of a potential loss onto the SBA.

The purpose of the debt you are planning to refinance also had to be an eligible one under 7(a) rules when you first took the debt out. This rule is waived if the reason it was ineligible no longer applies.

The SBA also has some additional requirements for refinancing debt that in turn was also used to refinance an existing loan. The debt had to have been part of your books for two full tax cycles at the time of refinancing. The proceeds from the loan must have all been used for appropriate business purposes, and you have to prove it. You must have documentation for all the original notes that were refinanced.

There are additional limitations when you refinance an existing SBA loan or refinance debt held by the same lender.

Only debt that fits at least one of eight criteria listed below qualifies for refinancing under the SBA 7(a) program. The last criterion is the most flexible, as your lender will decide.

Debt with a demand note or a balloon payment.

Debt with an interest rate higher than what the SBA allows for a loan of that size or term.

One kind of debt that the SBA specifically mentions is business credit card debt.

Debt secured by more collateral than the SBA would normally require.

If you have an existing revolving line of credit that the lender won’t renew, or that you want to restructure to get a lower rate or longer term, it can qualify.

When the term or repayment schedule doesn’t match the underlying reason for borrowing, it can spell trouble for cash flow. The SBA defines the maximum maturity by the use of the funds.

Debt taken on to fund the sale of a business.

If your lender is no longer meeting your needs, you can find a new lender with the 7(a) program.

Depending on which criterion applies, the lender may need to show that refinancing will improve cash flow by 10 percent.

The new loan will also need collateral and a lien position at least as strong as the old debt held. The new lender can also accept substitutes that have similar value and useful life.

The lender has to be able to show how the new terms would help your business and improve its operations.

When I apply to refinance debt with a 7(a) loan, what paperwork do I need to show the lender?

When refinancing debt with an SBA 7(a) loan, make sure you have all the original loan documentation. Also, make sure you have a formal payoff letter from your current lender before the new loan closes. In some cases the new lender will ask for further due diligence.

I want to move to a new bank that can offer me better rates. Can the new bank roll all my existing debt, including my current SBA loan, into one new SBA loan?

Under the 7(a) rules, refinancing an existing SBA loan is unlikely. The SBA already approved the longest term allowed for that loan amount. The SBA recognizes that a new lender may be able to offer you better terms, but says that fact alone is rarely a reason for them to approve refinancing. You’ll have to prove to your new lender that your debt no longer has reasonable terms.

I bought my business partly with seller financing, and the balloon payment is due next year. Can I refinance with an SBA loan?

Yes, this is an eligible use under the 7(a) rules. But you need to have the note recorded on your balance sheet, and at least 24 monthly payments made and recorded. If your note was on standby and you didn’t make payments, the rules say it doesn’t count toward the 24 monthly payments.

I’ve heard that business owners need to add new equity to their business to be able to refinance with a 7(a) loan. Is that true?

Ultimately, the decision to ask you for an equity injection is the lender’s. With a straight refinance, you won’t usually need one. But if your refinance is part of a larger business financing project, your lender might decide that an equity injection is needed.

Can I refinance personal debt that I spent on my business with a 7(a) loan?

Yes, it’s possible to refinance personal debt that you used to fund your business. But, as the 7(a) rules explain, it comes with a few nuances, and your lender may need to do some extra paperwork.

With debt refinancing, you may be able to pay off a home equity line of credit, as long as you and the lender both certify that the line was used exclusively for the business. You’ll need a raft of documents to back up that claim.

One of the most common ways to finance a small business is to fund expenses with personal credit cards. But as you may know, interest can quickly eat up a big chunk of the monthly budget. The SBA says you can refinance those credit cards with a 7(a) loan, as long as the loan documentation matches the use of funds. The lender has to certify which purchases were for the business and document why. It’s up to you to certify that the money only refinances business expenses. On top of that, your lender may need to look at your credit card statements and receipts for each business expense over $500.

Make a Significant Difference in a Company’s Financial Health

While refinancing will change the interest rate and perhaps extend the term, the real impact on your company’s financials may show up in cash flow. Here’s an example.

James had an idea for a new kind of furniture, and set up a Kickstarter campaign to get it off the ground. The furniture designer launched a patent-pending product. To get that far, he took out high-interest loans to develop the design, pay the vendor, and pay for inventory.

A year after the Kickstarter campaign, his furniture is selling well. But he can’t produce fast enough to fill the purchase orders he already has.

With a year under his belt, James has a business history to show. His local SBDC suggested a lender that makes SBA loans. And James knows he’s a good candidate. He applies for a $100,000 loan, most of it to build his inventory and the rest for working capital.

But when the lender sees his costly startup debt draining his future cash flow, it recommends a higher loan amount. The 15.99% interest rate on the old loan is way over the maximum rate for a loan that size and term. The lender approves a $150,000 loan that includes the refinance.

James can take on 300 new orders. The 7(a) loan saves him about $11,000 a year.