BEST PRACTICES: SBA INTEREST RATES

Jessica L. Conn, Esq.

Lenders can often experience problems in setting the correct interest rate on their SBA guaranteed loans. A variety of factors, including the borrower's needs and desires, the lender's underwriting requirements and the SBA's regulatory structure can all combine to make an otherwise straightforward determination, anything but. With the SBA's new fixed rate calculation, a carful reading of the SOP is required to ensure that the lender's efforts to meet the customers demands to not create eligibility problems. A few points to keep in mind:

A borrower using an SBA loan to finance its business, may prefer a fixed interest rate to fix costs in a predictable manner. At the same time, a lender loaning money to a business that cannot obtain credit elsewhere may need to rely on a variable rate to underwrite the loan. One common compromise is to have an initial interest rate that remains fixed for a specified period of time (i.e. the first 5 years), and then adjusts for the remainder of the loan. Under the 7(a) program, this is permissible, however, there are a few things that the lender should keep in mind in getting its approval and determining whether the interest rate falls below the SBA maximum rate.

The maximum allowable fixed rate on SBA loans is calculated as follows:

30 day LIBOR + 3.00% (LIBOR Base Rate)
+ Average of 5 year LIBOR swap rate and 10 year LIBOR swap rate
+ Applicable spread (varies by size and term of loan, i.e. for standard 7(a) loans greater than $50,000, maturing in 7 years or more, the maximum allowable spread is 2.75%)
= SBA maximum fixed rate

Therefore, as an example, on $100,000.00 7(a) loan that will mature in 10 years, the maximum allowable fixed rate today would be calculated as follows: 3.35% (LIBOR Base Rate) + 2.82% (Average of 5 year and 10 year LIBOR swap rates) + 2.75% (maximum spread) = 8.92%.The maximum allowable variable rate for the same loan would be Prime (currently 3.25%), LIBOR Base Rate (currently 3.35%) or SBA Optional Peg Rate (currently 4.00%) + the applicable spread. Today that would make the maximum variable rates our example loan 6.00%, 6.10% or 6.75% respectively.

If the interest rate will change at any point during the loan, no matter how long it stays fixed for initially, the SBA classifies it as a variable rate loan. That means that the lender must comply with all regulations that pertain to variable rate loans. For example, the lender cannot set a fixed rate of 8% for the first five years, and then convert to Prime + 2.75% because the initial rate exceeds the SBA maximum rate for variable rate loans. Therefore, if the interest rate is based on Prime, today, the highest initial rate a lender could offer is 6% even if it will not adjust for several years.

For these "fixed and variable rate" loans, the initial rate must be expressed in terms of its method of calculation. In other words, today, if a lender offered an initial Prime based rate of 5.50% (Prime + 2.25%), the authorization would read "The initial interest rate is 5.50% per year...The initial interest rate is the Prime rate...plus 2.25%." The SOP states that "Whenever a lender delays the initial adjustment period, the spread over the base rate used to calculate the initial Note rate must remain the same once the interest rate begins to fluctuate." Therefore, a lender is not permitted to offer the borrower a 5.50% rate today, that adjusts in five years to Prime + 2.75%, unless it obtains the written approval of the borrower at the time of the change.

By strictly following the SBA requirements regarding interest rates, Lenders will insure that they do not jeopardize the guaranty by making a loan that is later deemed to be "ineligible" for failure to adhere to the SBA's interest rate requirements.

For more information on this and other SBA eligibility related topics, contact Jessica Conn at

jconn@starfieldsmith.com

or 215-542-7070.

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