How a Rise in Early Loan Defaults Led to Big Changes at the SBA Published June 5, 2025
The Small Business Administration (SBA) has long been a cornerstone of support for America’s small businesses, providing critical access to capital through programs like the 7(a) loan program.
However, recent trends for the program paint a complicated picture, especially as leadership shifts at the federal level. A surge in early default loans, coupled with financial mismanagement and policy missteps, has left the agency on shaky ground. And now, the agency’s new Standard Operating Procedure (SOP) has been implemented to, in theory, course correct for this critical loan program.
The current state of SBA lending
The SBA’s 7(a) loan program is one of its most popular offerings, providing guarantees to private sector lenders who extend credit to small businesses. If a loan defaults, the SBA steps in to purchase a portion of the defaulted loan, reducing the risk for lenders and encouraging them to lend to small businesses. Over the past year, however, the program has seen a dramatic increase in negative loan statuses (SBA default rates increased to 3.7% in 2024, the highest since 2012), including defaults, delinquencies, and early defaults— loans that default within the first 36 months of their term.
According to the SBA’s FY24 Annual 7(a) Risk Analysis Report, these negative outcomes are at their worst since March 2020, when pandemic shutdowns disrupted the economy. While the SBA has pointed to rising interest rates as a primary driver, the rate at which these negative outcomes are increasing far outpaces equivalent measures in the private sector.
Why early loan defaults are a problem for the SBA
Early defaults are especially concerning because they occur close to the time of underwriting, suggesting potential flaws in the initial assessment of a borrower’s ability to repay. While it’s understood that circumstances can change over time, the SBA expects lenders to exercise prudence during the underwriting process to minimize the risk of defaults at the start of the loan relationship. When early defaults happen, they not only harm the small businesses involved but also place a significant financial burden on the SBA and, ultimately, taxpayers.
The Biden administration’s 2023 rule changes are a key factor in this trend. These changes relaxed underwriting criteria for 7(a) and 504 loans and expanded the participation of non-bank lenders that lack direct state or federal-level oversight. They also led to an increase in loans under $500,000, which have specifically exhibited higher credit risk. The intention behind these measures was to bridge the capital gap for underserved and minority businesses. While these efforts succeeded in increasing access to capital for many business owners, they also inadvertently opened the door to some subprime lending practices.
The result? A sharp increase in early defaults and a $1.6 billion purchase of defaulted loans by the SBA in FY24— the highest level since the pandemic. This has caused the 7(a) program’s net cash flow to turn negative for the first time in 13 years.
The 7(a) program is designed to be zero-subsidy, or self-sustaining, with all costs, including potential defaults, covered by the fees and interest paid by borrowers rather than by external funding or subsidies. However, the Biden administration’s decision to reduce fees has impacted this structure. From FY22 to FY24, the administration eliminated fees for borrowers on loans under $1 million and reduced fees for larger loans. Additionally, the guarantee fee for lenders on loans under $1 million was eliminated.
These fee reductions have created financial challenges for the program. With fewer fees collected and increased defaults, the SBA was primed to encounter difficulties in maintaining the program’s financial longevity.
Time for reform
In an effort to reverse some of these missteps, the SBA has initiated a series of reforms aimed at restoring the integrity of its flagship 7(a) loan program.
During the Biden administration, that decision to eliminate lender fees was touted as a way to reduce the cost burden on small business borrowers. By eliminating these fees, which were crucial for covering potential defaults, the SBA found itself in a precarious position, unable to fully cover the increased cost of failed loans. From 2022 to 2024, the SBA estimated that it failed to collect over $460 million in upfront lender fees, which contributed to the program’s first instance of negative cash flow in over a decade.
In addition to the reinstatement of lender fees, the SBA is also revisiting its underwriting standards. Under the previous administration, the SBA relaxed these standards to expand access to capital, particularly for underserved and minority-owned businesses. While these changes were aimed at increasing financial inclusion, they inadvertently led to an increase in defaults and delinquencies, particularly among loans under $500,000, which exhibited higher credit risk. Now, they’ve restored old policies, including the requirement of tax transcripts as a part of due diligence for loans under $350,000.
Looking Ahead
Another critical area of focus is interest rates. The 7(a) program is based on a variable interest rate model, which means that borrowers can see their monthly payments rise dramatically over time. In the past year, with interest rates increasing to historic levels, many borrowers who initially had manageable payments found themselves facing payment hikes that put their loans at greater risk of default. While this factor was largely outside the SBA’s control, it underscores the importance of careful underwriting and loan structuring — issues that have become central to the ongoing reforms.
SBA Administrator Kelly Loeffler has made it clear that these changes are necessary to protect both small businesses and taxpayers. She emphasized that while the 7(a) program has been a critical engine for economic growth and job creation, its sustainability is now in question due to the loosened standards and fee reductions implemented during the prior administration. By restoring lender fees, tightening underwriting requirements, and reevaluating the inclusion of non-bank lenders, the SBA is working to re-establish the program’s zero-subsidy status and ensure it can continue serving as a reliable resource for small business growth.
Looking ahead, the SBA plans to implement further changes to safeguard the future of the 7(a) program. These include greater transparency around loan outcomes, enhanced monitoring of default rates, and additional reforms aimed at ensuring that small businesses have access to capital without placing undue financial strain on taxpayers.
As these reforms take shape, the SBA’s efforts to correct course will be closely watched by both lawmakers and industry stakeholders. The success or failure of these reforms will have significant implications for the future of small business lending in the U.S., particularly as the country navigates an economic landscape marked by high interest rates and ongoing financial uncertainty.
