Typically, debt refinances are handled under the SBA 7(a) program. The SBA 7(a) program allows both short term and long term debt to be refinanced provided certain conditions are met. The lender must determine that the terms of the debt to be refinanced are unreasonable, the refinancing must provide a significant benefit to the business, typically through cash flow savings, and the credit facility to be refinanced must not be in payment default with the current lender.
 

Determining if short term debt such as a line-of-credit or credit card debt is eligible to be refinanced is fairly simple. Most lenders have come across a small business with a line-of-credit balance that does not seem to be reducing and therefore the business can no longer use it for its intended purpose, which is for short term operating needs. The same can be true of credit card debt, which may have been used to support an initial start-up period, since the business could not obtain a bank line-of-credit at the time.
 

Often times these LOC’s or credit cards were used to purchase fixed assets such as equipment. These types of short-term debt are typically eligible for refinance under the 7(a) program since the credit facilities are not being used for their intended purpose and can therefore be deemed to be on "unreasonable" terms by the SBA. Converting these short term facilities to term debt will help to restructure the balance sheet and thus a "significant benefit" will be provided to the small business. The conversion of short term credit facilities to term debt will usually result in a cash flow savings but it is not necessary.
 

Determining if long term debt such as a mortgage or equipment term loan is eligible to be refinanced is a little more complex. In some cases the eligibility decision is easy such as if the debt to be refinanced contains a balloon payment or is on demand basis. The SBA automatically considers these types of loans to be unreasonable and therefore a cash flow savings is not necessary. However, if neither of these conditions exist then the lender must demonstrate a 20% cash flow savings when refinancing long term debt. Obviously, the 20% cash flow savings test satisfies the "substantial benefit" requirement but it also typically demonstrates that the debt to be refinanced is on "unreasonable" terms.
 

For example, if the debt to be refinanced carries a variable interest rate and interest rates are increasing to the point where it hinders the growth of the small business, then the terms of the debt can be considered unreasonable. Refinancing this debt at a fixed rate or a lower variable rate, should "substantially benefit" the small business. If a lender is refinancing multiple debts, the change in debt service burden of each debt must be determined. No debt being refinanced is permitted to have a higher debt service requirement after debt refinancing than prior to refinancing and the overall cash flow savings must be at least 20%.
 

For the most part, the 504 program cannot be used to refinance debt. The spirit of the 504 program is to allow small businesses to finance the purchase of fixed assets with a minimal down payment. The basic structure of the program includes a bank first mortgage, typically at 50% of the project costs, a SBA 504 second mortgage, typically at 40% of the project costs and a borrower down payment, typically at 10%. The 504 second mortgage provides a long term, below market fixed interest rate. Eligible fixed assets include owner occupied real estate and machinery and equipment with a useful life of at least 10 years. Ineligible uses of funds include working capital and debt refinance. However, if an applicant purchases property with short term financing, perhaps from the seller, with the intention of obtaining long term financing later, then the project may still be eligible for 504 financing. If the short term financing is considered eligible based on ESCDC and SBA’s determination, then it could be paid off as part of the 504 project. This situation could apply to a seasonal business such as a waterfront motel, whereby the purchaser wants to take over the business at the start of the peak season and can close quickly with a seller financed transaction.