Equipment Financing: Know The Benefits & Drawbacks Before Signing

Katie Horne
Last Updated on August 5, 2020
Disclosure: Your support helps keep the site running! We earn a referral fee for some of the services we recommend on this page. Learn more

You have to have money to make money. When it’s time purchase necessary equipment and there isn’t enough money, where do the funds come from?

Enter equipment financing, a method of funding business equipment purchases. “Equipment” typically includes physical assets from office-related items like desks and printers, to farming-related equipment like tractors and pick-up trucks.

Like many types of loans, you’ll need something to act as collateral to back the loan. With equipment loans, the item you are purchasing can act as collateral, just like a car loan. If you default on the note, the lender can repossess the asset you purchased.

Equipment loans do tend to be more difficult to qualify for. In most cases, you’ll need a good credit score and a demonstrated ability to make the payments on your loan.

Which Small Businesses Can Benefit from Equipment Financing?

If you need equipment, but you aren’t able to purchase it outright, then you may benefit from equipment financing. There are two primary types of equipment financing which you, as a small business owner, should consider:

  • Equipment Loan: Equipment loans are great for those who want to own something, but are not in a place where they have the cash or alternative sources of credit to purchase it. These loans work exactly like personal car loans. At the end of the note, the borrower owns the equipment free and clear.
  • Equipment Lease: With an equipment lease, you are paying a fee to use a piece of equipment for a period of time. The person issuing the lease remains the owner, and you do not become the owner of the item at the end of the agreement.

Types of Equipment Financing And Eligibility

Let’s take a closer look at equipment loans and leases.

Equipment Loans

If you need equipment and you don’t have the cash-on-hand or enough credit to make the purchase, then you may be interested in an equipment loan.

Usually, you’ll pay a percentage of the equipment’s overall value as a down payment. Then, over a specified amount of time known as the “term” of the loan, you’ll make regular payments on the loan’s principle, in addition to interest costs. Until you pay off your loan, the lender is the ultimate owner.

equipment financing tools
If you intend to acquire equipment for long-term use with a long shelf life, outright ownership may be a better option than leasing.

For example, let’s say you own a flower shop and you need another refrigerator to keep up with your expanding business.

The refrigerator costs $3,000 and you agree to pay a lender 20%, or $600, as a down payment. The loan’s interest rate on the balance ($2,400) will be 10% and the term will be one year, with monthly payments.

On this loan, you’ll owe $211 per month for a year, after which you’ll own your fridge outright.

To calculate the ultimate cost of the loan, add the $2,532 of monthly payments plus the $600 down payment to get $3,132. That means you’ll have paid $132 over the original cost of the fridge to pay for the financing.

Pros

  • With an equipment loan, you will be the full owner of what you’ve purchased once the note has been paid off.
  • You do not need to come up with 100% of the required funds at the time of purchase.
  • You can use an equipment loan to amortize the cost over several months to prevent a massive one-time hit on your books.
  • In the event that the equipment you purchase is the collateral, you do not need anything else to secure the loan.

Cons

  • You’ll need to have enough cash to cover the down payment required.
  • Such loans are typically conservative instruments, so you will need a credit score of 600+ to qualify.
  • The total cost would be more than if you purchased the equipment outright, with cash.
  • If you default on the note, the lender can repossess the equipment.

Equipment Leases

Instead, if you want to want to use a piece of equipment but you don’t need to own it, you can consider an equipment lease.

With an equipment lease, you are paying a fee to use the item while the person offering you the lease is technically the owner. Equipment leases are a lot like renting an apartment.

Let’s take the example of a restaurant owner who wants to expand into the food truck service. You don’t want to buy a catering truck outright since you’re not sure if the business model will work for your menu so you decide to lease one.

The truck you’re looking at costs $50,000 to buy outright and you want to try it out for a year.

The lessor is asking for a 20% interest rate. Your lease payment will be $1,308 monthly.

Pros

  • Can use the equipment without paying the full cost upfront.
  • Good arrangement for those who don’t want or can’t to own.
  • Unlike equipment loans, some leases don’t require a downpayment.
  • Often comes with lower monthly payments than a loan.

Cons

  • Unless you’ve chosen “lease-to-own,” you won’t own the equipment at the end of your lease, so you won’t have anything to show for the money you’ve spent.
  • Though you may pay less on a month-to-month basis, leases tend to be more expensive in the long-run due to higher interest rates.
  • Leases do not improve your credit the way loans do (providing that you keep up with your loan payments).
  • If you decide to purchase the equipment at the end of your lease, you’ll pay more than if you financed the purchase with a loan.

Benefits of Equipment Financing For Small Businesses

If you can’t pay upfront for physical equipment that you need for your small business, equipment financing can help you get what you need to operate.

Furthermore, you can amortize the cost of an item over time. Regardless of whether you opt for an equipment loan or a lease, financing your purchase means that you know ahead of time what your base operating costs are for the next several months. You don’t have to wait to save up a lump sum to purchase the item today.

Is Equipment Financing Better Than a Small Business Loan?

Whether equipment financing is better than a small business loan depends on the business’ individual needs. In general, the rule of thumb is to purchase equipment (either outright or with a loan) if you plan on keeping something for several years, otherwise leasing is a popular option.

Who Gets An Equipment Loan?

Equipment loans are typically given to those with decent credit scores. Since the collateral is built-in, you’ll likely see a lower interest rate. However, you will need to provide a significant portion of the cost upfront, with the bank financing the remainder.

Is It Harder To Get a Small Business Loan?

Small business loans are slightly different from equipment loans. Eligibility depends on your personal credit score, the amount of time you’ve been in business, and your annual revenue. Often, though, equipment needs are immediate and can’t wait for a change in credit score or additional years of business operation.

Setbacks of Equipment Financing For Small Businesses

Any type of financing will increase the cost of the item you are purchasing in the long run.

In some cases, financing makes sense, especially if you aren’t going to be using something long enough to purchase it outright or if you don’t have the cash to do so. However, if there isn’t an immediate need for it, and you have time to save for the item, that’s the most efficient financial route to take.

Cheaper Doesn’t Mean Better

Furthermore, don’t be lured by the lower monthly payments afforded by a lease. If you need an item for three years or more, then it’s better to bite the bullet and finance it with ownership in mind. Deciding at the end of the lease to purchase the item means that it would cost you even more than if you had taken out a loan.

For those who want an equipment loan, consider whether you can take the upfront hit of up to 20% of the purchasing price. Although the cost is less than paying for the equipment outright, if you are operating on thin margins, then such a setback may be problematic for you.

How Much Will Equipment Financing Cost You?

Financing your equipment will result in the equipment costing you more in the long run. The specific term length for your loan depends on what you are financing. Lenders find it risky to hold notes on items that are obsolete. The increased amount over the cost of the item, however, depends on the type of financing you choose.

Equipment Loan Costs

When choosing an equipment loan, you’ll need to come up with an initial percentage of the cost upfront. You’ll also pay interest on the remaining 80% of the item’s cost.

Equipment Lease Costs

Equipment leases, however, are a bit different. You’ll agree with the lender on a monthly amount you pay for the duration of the lease. If at the end of the lease, you decide not to keep the item, you’re out the money you’ve paid, and you do not own the equipment.

In some cases, you may choose to purchase the item at the end of your lease. Some types of leases allow you to purchase it at its fair market value. Other leases are structured so that you have a low buyout value at the end of the lease terms.

How To Qualify For Equipment Financing

Many businesses can qualify for equipment financing since they’re fairly safe instruments. Keep in m ind that you’ll need to have a reasonably good (600+) credit score.

However, even if your credit score is lacking, you may still find yourself approved. You may compensate for a poor credit score by paying higher interest rates.

lendio equipment financing
Some financing companies like Lendio offer quick and simple application processes that don’t affect your credit score.

When applying for equipment financing, the lender will typically:

  1. Ask you to fill out an application
  2. Request tax returns and bank statements to prove the stability of your business
  3. Request a background and/or credit check
  4. Provide a quote for the equipment you’re looking to purchase

Finally, you will need to find a lender that will fund the type of purchase you are looking to make — not all lenders support purchases of any equipment.

How To Find Equipment Financing Companies

The first thing to do is to identify exactly what you’re looking to purchase, as lenders only tend to offer funds for certain products. For instance, Crest Capital offers funding for general equipment, vehicles, and software, whilst National Funding claims that they will allow you to finance or lease any type of equipment.

Downpayment Budget and Credit History

Other factors to consider are your budget (can you afford a downpayment?) and whether you’re looking for a lease or a loan. You’ll also need to consider your credit history, as well as what your past and future cash flows look like.

Annual Revenue and Eligibility

Certain lenders only work with businesses that bring in a specified amount of revenue and have been operating for a certain length of time.

Companies like Lendio help you explore options from over 75+ options in a few clicks with an obligation-free application process. Lendio also promises funds up to as fast as 24 hours for times when you need equipment in a narrow time-frame.

What Alternative Financing Methods Are There For Equipment Purchases?

Equipment financing isn’t your only option when it comes to paying for large purchases. You may also consider a small business loan.

There are a variety of small business loans available, though many are similar to an equipment loan. Unlike equipment loans, the collateral tends to be something else, not the equipment itself. Popular small business loans include:

Here is a brief comparison of the borrowing limits and the complexity of application processes.

 

Term Loan Business Line of Credit Merchant Cash Advance Invoice Factoring
What is it?  A conventional loan from a bank. Borrow varying or fixed amounts and pay-as-you-go.  Cash advancement for a chunk of future sales. Unfulfilled client invoices exchanged for cash plus a commission.
Borrowing Limit Over $250,000 $1,000 to $250,000 $50,000 to $2,000,000 $10,000 to $5,000,000
Application Process In-depth Moderate Moderate In-depth

 

Difference In Variables

The variables involved with small business loans vs. equipment loans are large, so you will need to get quotes on both options with your business’ specifics to accurately compare costs.

You may also find that your business is eligible for grants, either from government or from private parties. Grants are the best type of funding since they typically do not require repayment. The downside, however, is that the requirements for receiving a fund may be quite strict.

Additional Resources On Equipment Financing

If you would like additional information on equipment financing, we think you’ll find the following articles helpful:

Summary

Whether you choose an equipment loan or a lease, equipment financing can help you get the tools you need to run your business when money is tight.

It is, however, not a panacea for any money issues. Equipment financing still means that you’re spending more by paying more money for something in the long-run than if you had purchased it outright.

Do you have equipment financing tips for your fellow business owners? Please share them! More questions? Add your comments below and we’ll answer any questions you have.


Images: Detail Tools by FunGi_(Trading), licensed by CC 2.0

Read previous post:
grammar check software
Beyond Grammarly: 11 Top Grammar Check Software Apps Compared

When it comes to writing, good grammar is a must. In both personal and professional settings, good grammar helps make...

Close