Machinery breaks down, it's a fact of life. However, when a dry cleaning machine or a restaurant oven needs to be purchased, updated, or replaced, the costs can be prohibitively expensive, especially for a small business. Equipment loans can step in and provide fast access to what you need to keep your business going.
What Is an Equipment Loan or Equipment Financing?
Equipment loans, also known as equipment financing, are loans used to buy business equipment which are covered by the equipment itself. The amount of the loan itself can vary according to the cost and amount of the equipment needed.
Traditionally, banks would be the best place to obtain an equipment loan, with the most favorable interest rates and terms. However, their strict credit standards can mean that many businesses won't qualify. Online small business lenders have stepped in, to offer alternatives that are much more friendly towards companies that need to acquire equipment fairly quickly, or whose personal and business finances aren't in optimal shape.
No matter the source of the loan, a good tip is to match the term of it to the expected lifespan of your new equipment. A shorter term may find you scrambling to make payments, whereas a longer term can mean that you'll be paying off equipment long after its useful life.
How Do Equipment Loans Work?
Most businesses can qualify for equipment financing, with much less paperwork than a traditional loan. Most lenders will ask for:
- Driver's License
- Voided Business Check
- Bank Statements
- Credit Score
- Business Tax Returns
- Equipment Quote
Once the documents are in the hands of the lender, approval and subsequent funding tends to be quick, within a few business days.
Equipment Loan Costs and Repayment
Both the cost of your loan and interest rate will depend on the value of the equipment, your business’s financial history, and your credit score. Depending on the lender, you can obtain loans of between $2,000 and $2 million. APR rates can vary between six and ninety-nine percent. Be aware that in return for speed and less stringent qualifications, lenders will generally charge more.
Though some lenders have minimum credit score requirements, (585-650), since the equipment itself acts as collateral for the loan, companies with a less than stellar history or credit rating can still qualify. Most equipment loans are made at fixed interest rates—usually between 8% and 30%—with set term lengths, so you can expect the same payment each and every month.
Another advantage is that they allow companies to finance between 80 and 100 percent of the cost of the equipment, often without a down payment. Additionally, some financing companies offer flexible repayment terms which can help you maximize cashflow, a common issue with small or new businesses. Payments on equipment loans may also be tax-deductible as operating costs, but be sure to verify this with your accountant.
Equipment Loans vs Commercial Equipment Leasing
Another similar option is equipment leasing. Instead of taking out a loan to purchase equipment, you can also choose to lease it. However, this essentially means that you'll be making monthly payments just as with a loan, but must return the equipment once you discontinue payment.
Leasing is usually best left as a temporary, short-term solution, but it can also be a smart move. Consider that a piece of equipment becomes less valuable and productive as it gets older, so leasing it for a limited time may be preferable, if it's particularly vulnerable to wear and tear.
The best way to know which is more convenient for your company is to crunch the numbers for the longterm. If the equipment is essential to the proper functioning of your business, and you foresee using it for a long time, purchasing it is sure to be a more efficient use of your money.
What to Watch out For
Though equipment loans can offer a convenient, easy way to obtain the machinery you need, it's always important to read the fine print. Be sure to ask about defaulting, for instance. If you fail to pay off the loan, but the asset's value has declined since you purchased it, you may owe the lender the difference. Another thing to watch out for is to verify that the only collateral being put up is the equipment itself, and nothing outside it. Finally, if the loan allows you to effect a trade-in for an upgrade, find out what the shortest time period is before this can be done. Some financing companies will penalize you for trading in too early.