So your company needs to make a significant purchase. Whether it’s a new copier, restaurant equipment, or even a semi-truck, an equipment loan might be the perfect solution. Offered by banks and online lenders, the best equipment financing options can assist business owners who need new equipment to start or grow their business, or to repair and upgrade existing equipment to remain competitive. Although this loan can be easier to obtain approval for, it’s essential to consider its drawbacks.
What is an Equipment Loan?
An equipment loan is a type of financing that you acquire to purchase a specific piece of business equipment. The term “equipment” can encompass a broad range of items. Many companies take out equipment loans to finance the purchase of computers, office furniture, vehicles for commercial use, machinery, commercial kitchen equipment, HVAC units, phone systems, printers and copiers, medical equipment, and industrial equipment. In short, if your company needs to acquire a significant tangible asset, an equipment loan can help you break down the cost into manageable payments over time.
How Does Equipment Financing Work?
Equipment financing typically comes with a fixed interest rate and requires you to make periodic payments to repay the loan. The loan term usually falls between three to ten years. The equipment you’re purchasing serves as collateral for the loan. In other words, if you fail to repay the borrowed amount, the lender can seize the asset to recover some of their losses. Additionally, you may be asked to provide a personal guarantee, making you personally responsible for the loan in case your business can’t pay it back. This puts your personal assets at risk.
Many equipment loan options require a down payment, which can range from 10 percent to 20 percent, depending on the lender. The more money you can offer as a down payment, the more favorable the interest rates tend to be.
Equipment Loan Eligibility Requirements
As with any type of financing, banks, credit unions, and equipment financing companies will vet you before offering a loan. They will consider several factors, including your business credit score, personal credit score, the length of time your business has been operating (usually at least one year for approval), and your business’s profit and loss statement. It is possible to find lenders willing to work with business owners who have bad credit or limited time in business. However, the more favorable these factors appear to the lender, the more favorable the interest rate you’ll be able to secure on your equipment loan.
It’s important to consider not only the interest rate but also any potential costs associated with equipment financing, such as origination fees, late fees, or prepayment penalties. Be sure to read the fine print to understand the potential expenses involved.
Equipment Loan vs. Equipment Leasing
To draw a comparison, let’s think of this in terms of buying a car. With an auto loan, you pay more each month, but you own the car once you pay off the loan. On the other hand, when you lease a vehicle, you essentially rent it, which has its advantages.
Equipment leasing typically doesn’t require a down payment, making it a better option for business owners who can’t afford to tie up funds in equipment purchases. Another advantage of leasing is that it can protect you from depreciation or obsolescence. If you’re buying an asset that may not retain its value or relevance by the time your loan term ends, owning the asset outright might not be the most sensible choice for your business. Leasing it instead could be a more suitable option.
Pros and Cons of Equipment Loans
If you’re still deliberating between an equipment loan and a lease, it’s useful to weigh the pros and cons of equipment financing. Here are some of the advantages and disadvantages to consider:
Pros
- Protect cash flow: Even if your company could afford the equipment outright, a loan allows you to keep that capital liquid, which can be crucial for maintaining healthy cash flow.
- Support business growth: If the equipment will help your business scale to the next level, it’s a worthwhile investment. An equipment loan can enable you to take that step without having to save up for the full equipment cost.
- Fewer requirements than other business loans: Equipment financing generally has less stringent underwriting criteria compared to other types of small business loans. This means that even if your business is new or struggling, you may still qualify for this type of loan. Furthermore, because the equipment you’re purchasing serves as collateral, you may not need to put as much at risk to secure the loan.
- Tax write-off: A variety of business equipment can be written off for tax purposes. Additionally, you may be able to claim your equipment loan payments as operating expenses. Consulting with your accountant will help you explore how your equipment and its loan can potentially reduce your tax liability.
Cons
- Interest payments: Since this is a loan, you will have to pay interest, making the overall cost of the equipment higher than if you were to save up and buy it outright.
- Tightened cash flow: While equipment financing can save you from a significant one-time cash outlay, it does mean making regular payments to your lender. Evaluate your cash flow carefully and ensure your business can accommodate that recurring expense before committing.
- Significant downside if you default: Missing several consecutive loan payments and defaulting on your business loan will have serious consequences for your business and personal credit scores. The lender can seize not only the equipment but also other business assets — or even personal assets if you made a personal guarantee.
Where to Get an Equipment Loan
If the advantages outweigh the disadvantages for your business, here are several places where you can find equipment loans:
- Traditional banks and credit unions: Many financial institutions that offer various types of small business loans also provide equipment financing. While qualifying may require more stringent criteria, an equipment loan from a bank or credit union often comes with lower interest rates and better repayment terms compared to online or equipment-focused lenders.
- Online lenders: Online or fintech lenders typically offer streamlined applications, resulting in faster and more accessible funding. They can be a good choice for startups and business owners with less-than-excellent credit.
- SBA lenders: These equipment loans are backed by the Small Business Administration (SBA). Like equipment financing from banks and credit unions, SBA-backed loans generally have strict underwriting requirements but offer favorable rates.
- Equipment financing companies: Some companies specialize in providing loans specifically for purchasing business equipment. Similar to online lenders, getting approved for loans from equipment financing companies can be easier and faster, but they often come with higher rates and fees.
- Equipment manufacturers: Occasionally, the manufacturers of the equipment you intend to purchase offer financing plans. While this might seem convenient, these options often come with higher interest rates compared to other lending sources.
Bottom Line
An equipment loan can empower your business to acquire expensive tangible assets that will contribute to its growth. Since the equipment itself serves as collateral, this type of loan can be accessible to startups and borrowers with bad credit. However, like any financing option, there are costs involved, such as interest and fees. To ensure you are not overpaying, evaluate multiple lenders and their offerings before finalizing your decision.
Frequently Asked Questions
- What are typical terms for equipment loans?
- What credit score is needed for an equipment loan?
- Is it hard to get a loan for equipment?
Please note that this article was written with the purpose of providing general information and should not be considered financial advice. For specific advice tailored to your business’s unique circumstances, consult with a financial professional.