Are You Prepared to Make a Down Payment on a Business Loan?
Learn how much you’ll need to put down to qualify for a loan
When you take out a loan for a vehicle, a home, or any other purpose, the lender most likely requires a down payment equal to a percentage of the loan amount. These are essentially good-faith payments that reduce the lender’s risk and attest to your ability to repay what you borrow. A substantial down payment can also help reduce your overall debt, qualify for a lower interest rate, and make smaller monthly payments.
Business loans also often require borrowers to make a down payment. But how much should you anticipate putting down on a business loan? While many variables go into determining specific loan terms for any borrower, the average business loan down payment ranges from 10% to 30% of the total loan amount.
Why do lenders require down payments?
When a bank or other funding organization extends a loan, it is taking a risk. No matter how solid the borrower’s financial footing is when they apply for funding, there’s always a chance for things to get off track and prevent them from repaying the debt.
Therefore, lenders do everything they can to reduce their risk and prevent losses. This results in an application review process that includes evaluating applicants’ finances and track records with other debts, which is a substantial part of the process. Lenders also collect funds upfront to reduce their losses in the event of a default. Ultimately, lenders want reassurance that you can pay back what you borrow.
Common loan types and their down payment requirements
The term “business loan” can refer to a variety of different loan types, and depending on what you need the money for, your financing options can vary. Certain loan types always require a down payment regardless of your circumstances, such as Small Business Administration (SBA) 7(a) or 504 loans. Other loans have more leeway for negotiation.
SBA Loans
The SBA doesn’t provide direct funding but connects businesses to lenders and partially backs the loans with government funds. The agency offers a variety of loan programs (including some with no down payment requirement, such as Microloan and Disaster Assistance loans for extenuating circumstances), but most borrowers qualify for the 7(a) and 504 loan programs.
An SBA 7(a) loan allows you to borrow up to $5 million to finance everything from inventory and equipment to real estate. The downpayment on a 7(a) loan ranges from 10% to 30%, with new businesses and startups often at the higher end of the scale. SBA 504 loans, which are common for significant expenses like real estate and equipment, have more stringent qualifications and a 10% minimum downpayment. Less well-established companies should expect to put down at least 20%.
Term Loans
Term loans, or traditional bank loans, offer a defined payment schedule and either a fixed or variable interest rate. Down payments range from 0% to 20%.
Real Estate Loans
If you need to purchase property for your business, you can take out a commercial real estate loan. Most lenders require at least 20% and up to 30% for these loans.
Equipment Loans
Your business can finance equipment with a loan with a downpayment ranging from 0% to 20%. Because the equipment is collateral, lenders are often more willing to accept lower down payments from qualified borrowers.
How lenders decide whether you need to make a down payment on a business loan
When you take out a loan for your business, you don’t always have to make a down payment. If you do, the amount you need to provide upfront depends on several factors, many of which relate to your specific application. This means you might have to make a smaller or larger down payment for the same loan amount as another borrower.
When determining your loan terms, the lender will likely take into account:
Lender Requirements
Certain loan types, including SBA 7(a) and 504 loans, require borrowers to pay at least 10% upfront, regardless of other circumstances. Other lenders may also have non-negotiable down payment requirements. When comparing lenders, evaluate these policies to ensure you work with one that has the most reasonable standards and competitive rates.
Collateral
Some lenders allow borrowers to use collateral to replace some or all of the down payment. Offering collateral reduces the lender’s risk since they can seize the collateral to cover costs if you default. If the lender doesn’t accept collateral as a substitute for a down payment, you may still be able to negotiate a lower one.
Loan Amount
How much money you plan to borrow can also influence the down payment requirement. Some lenders view smaller loans as less risky, especially if you have a good credit history and solid business finances, and will waive the down payment or require a smaller one.
Loan Purpose
Some lenders will consider a no-down payment loan if you intend to use the money for specific purposes, i.e., those that will measurably increase your business’s profits and cash flow. If you can demonstrate that the loan will make a significant difference to your business growth, it may be possible to negotiate the down payment terms.
Business Creditworthiness
If you have a high credit score and a positive credit history, lenders are far more likely to negotiate the down payment for your loan. Lenders look at your personal and business credit scores and, in some cases, are willing to waive the down payment requirement for a low-risk borrower.
Secure the cash to qualify for a loan
Proof that you have the funds to make the down payment is part of the loan application process. Even if you expect to negotiate a lower (or no) money down, budget for the payment. This is especially important if you’re seeking an SBA loan that requires all borrowers to pay some of the loan upfront.
The question for many borrowers is how to get the cash together for this payment. You have some options:
- Personal savings or cash reserves
- Dip into your retirement savings
- Use a Rollover as a Business Startup plan if your business qualifies
- Seek angel investors to provide the funds for the loan down payment
- Reduce business expenses and use the savings
If your business comes up short on a down payment for a loan, you may need to seek alternative financing options that don’t require an upfront investment. For example, the SBA has a microloan program, which allows you to borrow up to $50,000 without a down payment. This program primarily caters to underserved markets, like women and minority business owners, and requires a solid business plan and financial projections.
Business loan alternatives
Lenders may offer non-SBA loans without down payment requirements as well. For example, you may qualify for a short-term loan to access money for immediate expenses. These loans have significantly shorter repayment periods and, in many cases, higher-than-average interest rates. However, these products can be a viable alternative for borrowers with a weaker credit history or new businesses willing to accept the higher costs.
Working with non-bank funding sources can also eliminate the down payment requirement. Although these lenders typically require collateral or a personal guarantee, businesses may secure funding without a down payment even if they don’t meet the stringent requirements of large national banks.
Lines of credit
Another alternative to a loan with a down payment is a business line of credit. A credit line allows you to withdraw money as needed; you can borrow again when you repay the draw. The SBA offers multiple credit line options, which may require a down payment, but you can apply for one with the bank you already work with or another lender.
Although a credit line can help with unexpected expenses, seasonal fluctuations, or other short-term needs, the interest rates are often higher than loans.
Find the perfect funding solution for your business with help from Finance Factory
Making sense of your business loan options can feel overwhelming, especially when you have a new business. The Finance Factory team is committed to connecting entrepreneurs with lenders who can help them grow their businesses and achieve solid financial footing.
If you have a credit score of at least 700, our partnerships make it possible to secure up to $300,000 for your business in as few as 14 days. Get in touch with us today by filling out the pre-qualification form (no hard credit check required), and let our experts walk you through the loan application process and help you secure funding with affordable rates and terms. We’re here to help you make the best decisions for your business and put you on track to taking your company to the next level.
