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Recent significant changes in the nation's largest government loan program for entrepreneurs have made it harder--and more expensive--for small businesses to get a federal loan. Find out who will still qualify.
Last Friday, despite last-ditch efforts in Congress, significant changes took effect in the nation's largest government loan program for entrepreneurs. As such, some business owners hoping to use the program may find themselves looking for new financing because they no longer qualify. Many who do qualify will pay higher fees for their loans. And in some cases, borrowers may find their local lenders, who also now face higher costs, less eager to participate in the program.
The upheaval comes at a time when both presidential candidates are trumpeting small-business owners as pillars of the economy. And it underscores the challenge of tying people's livelihoods to something as unpredictable as politics. Notably these latest changes could change yet again when Congress passes various pieces of pending legislation. If nothing happens this week before legislators adjourn, then everything stays as is until after the Nov. 2 elections.
Established in 1953, the 7(a) program is the single largest source of loan money for the nation's 25 million small businesses. Its purpose is to help entrepreneurs who might not qualify for regular loans because they don't have, say, sufficient collateral. The government collects fees from both borrowers and lenders for using the program.
"For most folks who use it, this is their only available source of funding," says Anthony Wilkinson, CEO of the National Association of Government Guaranteed Lenders, a lobbying group.
The 7(a) is run through the U.S. Small Business Administration and dollars are distributed through banks and other commercial lenders like the ones Mr. Wilkinson represents. The government guarantees a portion of the loans, up to around 85%, which makes them a pretty good deal for lenders.
The program's success can be measured in its growth: In 1954, the first full year 7(a) operated, the SBA helped finance 469 loans totaling a mere $27.3 million. This past fiscal year, $12.7 billion was lent to almost 75,000 small businesses.
After the attacks of Sept. 11, 2001, and the accompanying recession, Congress approved a reduction in fees with the 7(a) to spark the economy. Those reductions--as well as other borrower and lender-friendly elements of the program--expired on Sept. 30, at the end of the federal fiscal year. This occurred after members of Congress failed to pass legislation opposed by the administration, extending the lower fees and other policies.
Before getting to why they failed, here's a look at the changes. First, the main fee that business owners pay to borrow via the 7(a) program went up, in some cases doubling to 2% from 1%. It's called a guaranty fee, which is a percentage applied to the portion of the loan the SBA guarantees for lenders. For instance, someone taking out a $100,000 loan would now pay $1,700 vs. $850.
Simultaneously, the maximum amount the government will guarantee on a 7(a) loan dropped to $1 million from $1.5 million, which some lenders say makes them less eager to lend larger sums of money. The highest loan amount available through the program is $2 million.
What's more, lenders are no longer allowed to circumvent this $2 million cap by striking "piggyback" deals, where lenders offer a first loan themselves and combine it with an SBA loan in a more precarious second-lien position.
Regardless of the changes' merits, the uncertainty surrounding the program in recent months has left some entrepreneurs in a bind. For instance, Bob Hawkins in Lufkin, Texas, may now lose his deal to build a 10,000-square-foot truck stop because his lender believes a $2 million 7(a) loan will be too risky under the new lower guaranteed amount.
Having been told he'd qualify under previous guidelines, Mr. Lufkin raised $700,000 in investor loan money, which may disappear, and spent $35,000 of his own on engineering, legal and other costs.
His lender says the real problem is the 7(a)'s lack of stability. "Just don't change the rules of the programs every six months," says Robert Tannenhauser, CEO of Business Loan Express LLC. The uncertainty stems in part from philosophical disagreement among the Bush administration and members of Congress about how 7(a) should be funded overall. In years past, Congress has appropriated a certain amount of money annually--$79 million in 2004--as a subsidy to cover potential losses on the program and keep it operating.
The administration, however, has proposed moving to a zero-subsidy plan for 2005. That would mean that the 7(a) program would be operated via fees collected from lenders and borrowers, not a government appropriation. The SBA says such a move will streamline the program, reduce the burden on taxpayers, and stabilize funding.
With last week's fee increases, the SBA now has a window to give its zero-subsidy policy a trial run. "The administration did not propose raising fees," says Anthony Bedell, the SBA's associate administrator for congressional and legislative affairs. "We simply used the opportunity of the fees returning to their historical levels to implement a zero-subsidy policy for the 7(a) loan program."
Critics say that such a move is premature and will crimp small businesses' ability to obtain funding at a time when the economy has not fully recovered.
"After Friday, thousands of small businesses are now struggling to cope with a sea change in the way they do business as a result of the Small Business Administration's insistence on implementing higher fees -- virtually overnight," says Republican Sen. Olympia Snowe of Maine, whose legislation postponing the fee hike and keeping the higher guaranty amount, among other things, stalled in the Senate. Similarly, Rep. Nydia Velázquez, the ranking Democrat on the House Small Business Committee plans to continue to push this week to get fees lowered again before Congress adjourns.
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