The Businesses Owner’s Guide to Equipment Financing
Having the right equipment for your business, whether it’s a product or a service, is critical to keeping it running properly. Replacing, upgrading, or purchasing equipment for the first time can place a strain on your cash flow, but with the appropriate equipment financing, you can receive the equipment your business requires without breaking the bank.
Equipment financing comes in a variety of formats, and what works for one company may not work for another. You will have a better grasp of: after reading this guide:
- How does equipment financing work?
- How do the various financing options stack up?
- What are the advantages and disadvantages of each?
What is the definition of equipment financing?
Equipment finance is a type of financing that is tailored to the acquisition of commercial equipment. Your business manufactures monthly payments toward the debt, and after the obligation is paid off, you own the equipment outright. Certain methods of equipment financing use the equipment as collateral, allowing the lender to take possession if you default.
The lender may impose a blanket lien or seek a personal guarantee, depending on how the financing agreement is structured. If you default, a blanket lien permits the lender to seize all of your business assets, including the equipment. A personal guarantee does the same thing with your own assets, so it’s crucial to know what you’re agreeing to before taking out a loan.
Leasing vs. equipment financing
You don’t have to buy equipment if you don’t want to—you may lease it instead. This means you’re paying the equipment’s owner rent on a monthly basis, just like you would if you were leasing office or retail space for your business. You have the option of renewing your lease or purchasing the equipment all together at the end of the lease period.
Leasing has a benefit over financing in that you are not needed to make a down payment in order to get the equipment, as you would with a loan. In most cases, there are no restrictions for collateral, liens, or personal guarantees. If your business or personal credit is less than ideal, it may be easier to qualify for a leasing agreement rather than financing.
However, there is a possible disadvantage in terms of cost differences. You are not locked in as far as ownership when you lease equipment for a lengthy period of time, but you may end up spending more to rent than you would if you bought the equipment instead.
What are the choices for equipment financing?
Small business owners have a variety of options for financing the equipment they require. Several criteria play a role in determining which one is the greatest fit, including:
- Your personal and business credit ratings
- How long you’ve been in business
- Your annual business income
- The loan amount you want to take out
- The repayment terms you want to use
With that in mind, consider the following five options for financing equipment:
- Equipment Loans
Best for: Newer businesses who seek to expand their operations and need equipment finance.
An equipment loan closely resembles the previous definition of equipment financing. The equipment serves as collateral for the loan, and up to 100% financing is conceivable, but some lenders may need a 20% down payment.
Depending on how much you borrow, repayment durations can be as little as 36 months or as long as ten years or more. Loan limits for equipment loans range from $50,000 to $10,000,000 with an annual percentage rate of between 8% and 30%.
Equipment loans can typically be funded in as little as two business days. Because many equipment loan and term loan providers solely operate online and do not have a physical site, underwriting is frequently significantly more efficient. Fill out an application, upload documents like bank statements or tax records, and receive an approval decision in as little as 24 hours. With a traditional bank, you may have to wait days, if not weeks, for your application to be processed. Obtaining an equipment loan does not necessitate having perfect credit. Lenders often expect you to have been in business for at least one year before applying, so if you’re still in the startup period, you may have a harder difficulty qualifying.
- Term Loans
Best for: Businesses that have a steady stream of revenue and need to borrow up to $1 million.
Small business owners who require immediate financing for an equipment purchase can consider term loans. Term loans, like a mortgage or a vehicle loan, are repaid over a specified length of time as their name suggests. Annual percentage rates are similar to those for equipment loans, and they can be fixed or variable.
Term loans are either secured or unsecured, depending on the amount borrowed. If you don’t want to utilize the equipment as collateral, you might have to replace another business asset.
Term loan lenders may have more strict credit requirements than equipment loan lenders. For example, an equipment loan can be obtained with a credit score as low as 600. To qualify for a term loan, you must have at least two years of business experience, generate at least $200,000 in yearly revenue, and have a personal credit score of 660 or higher.
While the approval criteria may appear to be more strict, this can work in your favor if you can use a higher credit score to qualify for a cheaper interest rate. You might also be able to negotiate a lower origination fee, lowering your borrowing costs even further. Even a one-percentage-point difference in the APR or the origination charge can save you thousands of dollars over the life of the loan.
- CDC/504 loans from the Small Business Administration
Best for: SBA-eligible businesses in need of up to $5.5 million in equipment financing.
The Small Business Administration offers many lending programs for small business owners, including the CDC/504 Program, which can be used to finance equipment acquisitions. For-profit businesses with a tangible net value of less than $15 million and after-tax revenues of less than $5 million in the previous two years are eligible for this program.
The CDC/504 loan, in contrast to equipment or term loans, has higher lending limitations. Businesses that meet the criteria can receive up to $5.5 million in finance, with loan durations of up to 20 years. A personal guarantee is also required in addition to the equipment.
A fee of 3% of the loan amount will also be charged to business owners. The fee alone would add $165,000 to the cost of borrowing the maximum amount of $5.5 million. However, in terms of percentage, this is comparable to what other lenders charge for equipment or term loans.
The 504 loan offers the longest funding horizon of the five alternatives. The various stages of the application and approval process, as well as receiving the loan profits, can take up to 8 weeks. If you need to buy equipment quickly, this is a huge drawback.
- Small business line of credit
Best for: Businesses in need of quick and flexible equipment financing
A business line of credit works similarly to a personal or home equity line of credit in that the bank makes a specific amount of money available to you that you can use over and over. If you operate a well-established business with a proven track record and an excellent credit score, you may be eligible for a line of credit of up to $1 million.
Business lines of credit might be repaid in a few months or over a five-year period. Funding can be completed in as little as a few days, and a low credit score isn’t usually a huge stumbling block to approval. However, this means you’ll have to pay more in interest.
When it comes to purchasing equipment, business lines of credit lose some of their sparkle when compared to other financing options. Rates might easily be in the area of 36%, which can quickly add up to a significant increase in the cost of your equipment. Because a business line of credit is intended to be used in the near term to address transitory cash flow gaps rather than huge, one-time expenses, it is not suitable for large, one-time expenses.
You may, for example, utilize your line of credit to cover payroll one month and repay it the next, or to stock up on inventory when business is slow.
- Business credit card
Best for: Owners of small businesses that want to get rewarded for small equipment purchases
Business credit cards typically offer the lowest credit limits among the financing methods discussed here, with a credit limit of $100,000 in most cases. That isn’t to say that when it comes to purchasing equipment, business owners should completely disregard them.
The potential to earn points, cash back, or travel miles for your business is the main benefit of using a credit card for equipment. If you have a card that earns 3% cash back and use it to charge a $15,000 oven for your restaurant, for example, you will effectively be getting a $450 discount. That’s something you won’t find with any other type of finance.
The interest rates and fees are two of the main drawbacks. APRs on credit cards are frequently in the double digits, and annual fees on rewards cards are not unusual. If you can’t pay off the item in a reasonable amount of time, the interest could overshadow the value of any benefits you get.
If you’re dealing with an equipment vendor who refuses to accept credit card payments due to merchant costs, you might have problems. If the vendor accepts credit cards, they may pass the cost on to you, making a credit card more expensive than a term loan, for example.
Consider all of your possibilities.
When looking into equipment financing, there are a few factors to keep in mind to assist you decide which course to take. Take a look at the entire cost of borrowing first. A low interest rate may be enticing, but you also need to consider if you’ll have to pay a loan origination fee or an annual maintenance fee, which could increase the overall cost, which is why it’s better to focus on the APR, which includes all loan fees.
After that, consider the payback terms. A shorter period implies the debt will be paid off sooner, but it may also mean a higher monthly payment.
If you choose a longer term, your payments will be lower, putting less burden on your monthly cash flow, but your total interest will be higher until you’ve paid for the equipment in full.
Finally, have a look at the lender’s approval conditions. You must ensure that your credit scores, time in business, and annual revenue all match the minimum requirements. You should also know whether a down payment or additional collateral than the equipment is required, as well as the lender’s stance on personal guarantees or liens.
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