Should You Repay an SBA Loan Early?

If you have extra cash on hand, paying off your debt early may seem like a clear-cut choice. But if you have an SBA loan, the decision may not be that simple. Many SBA loans have prepayment penalties, meaning paying early can come with an added cost that cuts into your potential savings.

Both SBA 7(a) and 504 loans have prepayment penalties. SBA microloans and disaster loans, on the other hand, do not have prepayment penalties.

A prepayment penalty is a fee that lenders charge when you pay off your loan before its maturity date. When you pay early, lenders lose out on the interest that they expected to receive from your loan. Prepayment penalties are designed to help recover some of that loss.

The U.S. Small Business Administration charges a prepayment penalty — called a “subsidy recoupment fee” — on SBA 7(a) loans with repayment terms of 15 years or longer.

You’ll owe this fee only if you repay more than 25% of your loan balance in a single year during the first three years after you receive the funds^[0]. If you make smaller prepayments — less than 25% of your balance in a given year — you won’t trigger the penalty.

Here’s how the fee works:

• 1st year: 5% of the total amount you prepaid.

• 2nd year: 3% of the total amount you prepaid.

• 3rd year: 1% of the total amount you prepaid.

After the third year, you can repay your loan early without any fee.

Shorter-term SBA loans — those with terms of 14 years or less — don’t have prepayment penalties.

All SBA 504 loans have prepayment penalties. The prepayment penalty only applies to the CDC portion of the loan. (As a reminder, 40% of an SBA 504 loan is funded by a certified development company, or CDC.)

For 20-year or 25-year 504 loans, the fee applies during the first 10 years of your loan. It starts high and decreases each year. In the first year, the prepayment penalty is equal to the interest rate on the CDC portion of the loan (called the debenture rate). Then, it decreases by 10% each year until it reaches zero after year 10^[0].

For 10-year 504 loans, the fee works similarly. It applies for the first five years of your loan. Again, in the first year, the cost is the same as the interest rate on the CDC loan. It then decreases by 20% each year until it reaches zero after year five.

Unlike 7(a) loans, partial prepayment is not allowed on 504 loans; these loans can only be prepaid in whole.

Although you may face prepayment penalties, there are still benefits to paying off your SBA loan early. Here’s a few to consider:

• Interest savings. If you repay your SBA loan early, you can save on interest costs over the life of the loan. Let’s say, for example, you have a $100,000 SBA loan with a 10% interest rate and 10-year term. If you repay three years early, you could save nearly $7,000 in interest costs.

• Improved cash flow. Without a monthly loan payment, you’ll have more cash available to use for other business purposes.

• Peace of mind. Eliminating debt can relieve stress and financial pressure — especially during seasonal or economic slowdowns.

Repaying your SBA loan early can also have drawbacks, such as:

• Prepayment penalty. The added cost of a prepayment penalty can eat into your potential interest savings from repaying early.

• Draining cash reserves. Using your cash reserves to pay off your loan early could leave you short on working capital for everyday expenses, emergency costs or new growth opportunities.

Follow these steps to determine if repaying your SBA loan early is right for you.

You’ll want to understand your loan terms and how potential prepayment penalties may impact you.

Let’s say, for example, you have an SBA 7(a) loan with a repayment term of 15 years. You’ll face a prepayment penalty if you want to repay more than 25% of your loan balance in any single year during the first three years of the term.

If you’re not sure whether your SBA loan has prepayment penalties, you can review your loan agreement or contact your lender for assistance.

Calculate how much interest you’d avoid by paying your loan early. You can use SS’s SBA loan calculator to make the estimates yourself or reach out to your lender for the exact calculations.

Compare the potential savings to the cost of any prepayment penalty. If the projected savings are greater than the penalty, it may make sense to repay early. If the savings are only slightly higher, it may make more sense to wait.

Saving on interest isn’t the only factor to weigh when deciding whether to repay your SBA loan early. Look closely at your current cash flow and make sure you’ll still have enough to cover everyday expenses after making a large payment.

Also, consider whether that money could have a bigger impact elsewhere, such as reinvesting in your business, expanding operations or building up an emergency fund. Maintaining healthy cash reserves allows you to stay flexible if you experience a slow period or unexpected expenses.

Before making a decision, it can be useful to consult a certified public accountant (CPA) or similar financial advisor. These professionals can help you estimate potential savings and prepayment penalty costs. They can also evaluate cash flow and tax implications — and help you take the right steps for your financial situation.