Down Payments: Do I Need To Put Money Down To Get A Small Business Loan?

If you’re a small business owner, you already know that growing, taking care of emergencies, and even just handling day-to-day operations takes capital — and lots of it. Sometimes, when expenses pile up, it makes sense to consider turning to a small business lender for a helping hand.

After you’ve calculated the amount you need, selected a lender, and started the application process, however, you may hit a financial roadblock: You need ready money to put a down payment on the loan.

To obtain a small business loan — especially for a large amount — lenders often require the borrower to pay a percentage out of pocket as a down payment. But why is this required? It seems a bit counterintuitive, after all. You’re borrowing money because you need more, but you have to pay money upfront to receive the loan.

Is there a way around this apparent catch-22? What loans require down payments, and what are your options if you don’t have the funds to pay it? Read on to find out more.

Why Lenders Require Down Payments

If you’ve ever taken out a large loan before, you’re already familiar with down payments. Car loans and mortgages are two examples of loans that require down payments. Let’s say that you go to the car dealership to purchase a car for $30,000. A 10% down payment is required. That means you will pay $3,000 out of pocket, and the lender will loan you the remaining $27,000.

Down payments work the same way for business loans. But why do lenders require it?

Requiring a down payment is just one of the ways that lenders lessen their risk. When you make a down payment, you’re investing your own money, which demonstrates to the lender that you’re serious about the loan and more likely to pay it back. It will also be easier for the lender to recoup at least part of their money in the event of a default. If an asset must be repossessed to pay off the debt, the lender will not have to sell the item for the full value to recoup their investment.

Of course, down payments aren’t just good for lenders — they benefit you, too. By putting up a down payment, you’re able to lower the amount of money that you borrow. This means that not only will your monthly payments be smaller, but you also will save on interest over time, making the loan more affordable over the long term.

Do All Business Loans Require Money Down?

Most larger business loans — including commercial mortgages, commercial auto loans, and equipment loans — do require a down payment to get approval for funding.

Whether a down payment is needed at all — and, if so, the required amount — will often vary based on the buyer’s creditworthiness. For example, a borrower with a solid history may qualify for a “zero down” offer or very low down payment. In contrast, a borrower with a troubled credit history may be required to pay a down payment to be approved for the loan.

One thing to consider is that when there is a minimum down payment requirement, it’s a wise move to put more money down, if possible. This means you’ll need to borrow less money, leading to lower payments and long-term interest savings.

How Down Payment Costs Are Decided

There are a few factors that determine the cost of a down payment. The first is the lender’s policies. Lenders may automatically require a down payment for specific loans or loans that exceed a certain amount.

Credit history also plays a role in the amount of the down payment. Down payment requirements are often lower for borrowers with high credit scores and solid credit histories. In some cases, these borrowers may even qualify for no-down-payment offers. Borrowers with low scores may be required to make a down payment before even being considered for a loan.

Collateral may also play a role in the amount of the down payment. If sufficient collateral has been put up to cover the loan in case the borrower defaults, a down payment may not be required. For other loans with no specific collateral requirements, a down payment may be required based on the loan amount and the borrower’s creditworthiness. This also holds true for loans where the assets being purchased with loan proceeds (such as vehicles, real estate, or equipment) serve as the collateral.

Typical Down Payment Amounts By Loan Type

Whether a loan requires a down payment is based on a number of factors, including the type of loan selected. For some loans, a down payment is always required but may vary based on the borrower’s profile and other considerations, such as the loan amount. For other loans, a down payment may not be required at all.

Learn more about down payment requirements for each type of loan below.

Bank Loans & Lines Of Credit

Business loans from a bank are typically reserved for the best borrowers. Even so, banks want to protect themselves from risk as much as possible, which is why a down payment to receive a loan is required, especially for higher loan amounts.

The typical down payment requirement for a bank loan is 10% to 20%. The down payment amount will be based upon the amount borrowed, how the loan funds will be used, the borrower’s credit history, and how the loan will be collateralized.

Business lines of credit from a bank are different in that a down payment is not required. Secured lines of credit may require collateral but will not require a down payment. Learn more about collateral requirements for business loans. A personal guarantee or blanket lien may be required in place of specific collateral for some loans.

Online Loans & Lines Of Credit

More business owners are turning to online loans because they are convenient to apply for, are funded quickly, and have qualification requirements that are less strict than conventional loans.

Online loans and lines of credit are also a top choice for business owners for another reason: They do not require a down payment. However, for most loans, collateral or a personal guarantee will be required to secure the loan. Learn more about personal guarantees before applying for your next loan.

SBA 7(a) Loans

SBA approved intermediary lenders typically require a down payment of 10% to 20% for 7(a) loans. The down payment amount is based on the borrower’s credit history, the amount of the loan, and the amount of collateral, if any, used to secure the loan.

The Small Business Administration 7(a) program provides loans to small businesses through intermediary lenders. Like other lenders, SBA intermediaries will require a down payment that is sufficient to mitigate risk. These loans are very popular because of their high limits (up to $5 million), low-interest rates, and flexible terms.

SBA CDC / 504 Loans

For SBA 504 loans, the SBA typically requires 10% down. The CDC provides 40% of the total project cost as a loan, while the second lender loans 50% of the total cost. This leaves the borrower with the remaining 10% to be paid as a down payment. Based on the borrower’s credit profile and the amount funded, an additional 10% to 20% may be required by some lenders.

SBA CDC/504 loans are loans used for the purchase or improvement of commercial real estate. With these types of loans, a borrower works with two lenders — an SBA-approved Certified Development Company and a traditional lender such as a bank.

Business Acquisition Loans

When money is borrowed to acquire a business, a down payment is required. Again, it all comes down to the risk posed to the lender. Low-risk borrowers with stellar credit scores and high-value collateral can often receive down payments for business acquisition loans as low as 10%.

However, loans for borrowers with lower credit scores, loans of higher amounts, or loans that aren’t fully collateralized may require higher down payments of up to 20%.

Commercial Real Estate Loans

Many lenders require a minimum 10% down payment for commercial real estate loans. However, requirements vary by lender. In some cases, up to 30% of the purchase price may be required as a down payment.

Commercial real estate loans are used to purchase land or property for commercial use. A commercial real estate loan is similar to a personal mortgage, including the need for a down payment.

With commercial real estate loans, the lender considers the loan-to-value, or LTV, ratio. That means the lender compares the appraised value of the property to how much the borrower is requesting. A higher LTV poses more risk for the lender, especially when the borrower doesn’t have a solid credit history. To lessen this risk, a higher down payment may be required to lower the LTV.

The SBA CDC/504 loans discussed previously offer an alternative if you’re looking to purchase commercial real estate with a lower down payment.

Equipment Loans

An equipment loan is a type of financing used to purchase equipment and machinery needed for a business to continue or expand operations. Equipment loans may require a down payment, although there are options available for 100% financing with no down payment required. Equipment that holds its resale value will most often qualify for very low or no down payments. Because it serves as the collateral and can be repossessed and sold if the loan goes into default, there is less risk for the lender.

However, depending on the amount of the loan needed and other factors, including credit history, an equipment loan may require a down payment of up to 20% of the total value of the equipment.

Invoice Financing

With invoice financing, lenders provide an advance on cash for unpaid invoices. This type of loan is best for businesses that have cash flow issues due to unpaid invoices.

With invoice factoring, the lender provides you with a percentage of cash upfront. Once the lender collects payment from the customer, the remaining amount is paid to you, minus any fees and interest collected by the lender.

Invoice discounting is similar. However, most of the unpaid invoice is advanced to you upfront. Once the customer pays you, you pay back the advanced funds, along with any fees and interest charged by the lender.

With invoice factoring and invoice discounting, the unpaid invoices act as the collateral. Because the collateral reduces the risk for the lender, there are no down payments required for this type of loan.

What To Do If You Can’t Afford A Down Payment

You need a loan to expand your business, but you can’t afford the down payment — now what? Fortunately, there are a few steps you can take when you’re struggling to come up with the funds to make the down payment.

The first thing you can do is consider different loans to find options with lower down payment requirements. SBA loans typically have lower down payment requirements than loans from banks. If you meet the SBA loan qualification requirements, consider applying for SBA loans, which also have very competitive rates and terms.

You can also explore loan options that don’t require a down payment, such as online loans and lines of credit. Remember, though, paying a down payment will help reduce the amount that you borrow, the monthly payment, and the overall cost of the loan.

Another strategy involves credit cards, but not in the way that you might think. While you can certainly choose to put a down payment on a credit card, this isn’t a wise financial move. Interest charges will rack up as long as there is a balance, keeping the business in debt. Instead, this strategy involves paying off your credit cards and other debts. Once old debts are paid off, the money that was being used to pay balances, plus interest, can then be applied toward the down payment.

If the financing need isn’t immediate, you can also consider saving the money. You can put money in a savings account or into certificates of deposits, money market funds, or other short-term investment vehicles.

If a low credit score is an issue that contributes to a high down payment, pull your free credit report and score and get to work building your credit profile to qualify for lower down payments — along with improved interest rates and terms — in the future.

While it’s possible to use credit cards or other borrowed funds to pay your down payment, this ultimately just adds to your business debt, so it’s best to avoid these methods, if possible.

Final Thoughts

A down payment for a small business loan may seem like an inconvenience, but this requirement is put in place to protect the lender. The good news is that the lender isn’t the only one that will benefit. Having a solid down payment for your business loan will help you save money over the long term in interest fees while also reducing your monthly payments and lowering your debt — all keys to smart, responsible borrowing.