Lenders require deposits for small business loans because they help to manage the risk they take when lending money and to follow regulations like the Basel framework that aim to keep the banking system safe and stable. While deposits for loans are common practice across lenders, the exact deposit required varies based on each lender’s internal guidelines and other loans they have made.
Don’t be afraid to shop around since one lender might require a 20% deposit and another might only require 15% for the same loan.
If you make a larger deposit up front, you may get a reduction on the interest rate, saving you money over the course of the loan. A $200K loan with a $20K deposit at 6% for 15 years would cost you $103,788 in total interest. A $210K loan with a $10K deposit at 7% would cost you $129,757 in interest.
If you don’t have the money for a deposit right now, keep reading to learn what you can do to increase your chances of securing another type of business loan.
Deposits Help Lenders Manage Risk and Stay Compliant
For real estate, equipment financing, and similar loans, lenders will manage their risk by setting a maximum loan-to-value ratio (the amount of the loan divided by the total purchase price) that determines how much borrowers need to deposit.
This is less risky for the lender if the property loses value since they would have to sell the property to recoup their money in case the borrower defaults. It is the same reason most people have to put 20% down on a home mortgage.
For a business example, if you wanted to buy a bunch of new machines for $375,000 and the lender had a maximum loan-to-value ratio of 85%, your deposit would be $56,250 and the bank would then lend you $318,750 based on the loan-to-value formula:
- (100% – Loan-to-value (LTV)) * Total Purchase Price = Deposit
- (100% – 85%) * $375,000 = $56,250.
If the loan was for five years at 10% interest and you stopped making payments after one year, the remaining principle would be $267,027.04 versus $314,149.46 had the bank loaned the full purchase price.
If the fair market value drops evenly by 20% over the five years of the loan, the equipment would be worth only $300,000 after one year. The bank would have no shot at recouping their money in this case if they had loaned the full purchase price.
Deposits also help lenders manage risk across their entire business because they use these deposits to make more loans, spreading their risk across more borrowers. This helps lower the probability of them losing money from defaults.
Lenders can require deposits for unsecured small business loans where you’re funding the business itself. In these cases, the deposit goes toward equity in the company and shows you have skin in the game. To qualify for an unsecured business loan, you will likely need to make a personal guarantee or agree to a UCC filing if a deposit is being waived.
In addition to managing risk as a part of their ordinary business, lenders require deposits to follow federal regulations that limit the amount they lend to any one business or person, set specific underwriting and LTV requirements, or determine how much they can loan out in total.
What to Do If You Don’t Have the Deposit Cash Right Now
If you don’t have cash for a deposit right now, start by talking with your accountant to see if you can free up cash with tax strategies like using a Section 179 deduction together with bonus depreciation. This deduction may apply if you bought assets this year and may lower your taxable income, letting you keep more revenue. If Section 179 does apply, you can leverage the cash you would have used to make estimated tax payments to fund the deposit instead.
If that isn’t an option and you can’t find a lender with an LTV limit high enough to make the deposit affordable, get documents from the lender on their policy and use them to apply for an SBA loan.
One of the SBA eligibility requirements is that you cannot find the financing you need elsewhere. Some SBA loans still require deposits, but because this is a government-backed program, the maximum LTV can be higher when it’s required.
A third option is to get equity investors to fund the deposit. Since they get paid from profits, you would get the cash you need now, qualify for the loan to grow your business, and then both you and the investor could make more money.
Bonus-tip: If you don’t want third-party investors, you can invest in yourself by using a HELOC, borrowing from your 401(K), doing a cash-out refinancing, or getting a personal loan to fund the deposit.
Not all business loans will require deposits. When they do, it’s so that the lender can share the risk. Each lender will have a different amount and internal guidelines. Want to find the right match for your business quickly and easily? Fill out our simple online form to see your matches today.
