Jun 09 2021by John Matheson

Equipment Financing: How It Works & What You Need To Apply

If your company needs improved equipment, or if you are starting out and you need to invest in equipment, this can be a significant financial hurdle to overcome. The good news is that it is possible to finance your equipment without using any other start-up funds or business funds you have.

What is Equipment Financing?

Let's start at the beginning: what is equipment financing? Equipment finance is a type of financing that is tailored to the acquisition of company equipment. Your company makes monthly payments toward the loan, and after the obligation is paid off, you own the equipment outright.

Equipment Financing Often Uses the Equipment as Collateral

In some cases, the equipment itself is used as collateral, meaning that if you do not make payments as agreed, the equipment can be repossessed.

The lender can do so by imposing a blanket lien or seeking a personal guarantee, depending on how the financing arrangement is written. If you default, a blanket lien permits the lender to seize all 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.

While it might sound harsh, the advantage of your equipment being used as collateral is that it can be easier to get financing. If you are trying to secure equipment financing without using the equipment as collateral, the bank takes a much more considerable risk. Using the equipment as collateral lowers their risk, and your chance of approval could be higher.

The Difference Between Financing and Leasing Business Equipment

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 to rent monthly, just like you would if you were leasing office or retail space for your company. You have the option of renewing your lease or purchasing the equipment altogether after the lease period.

The Five Options for Financing Equipment

Small company entrepreneurs have a variety of options for financing the equipment they require. Several criteria play a role in determining which one is the greatest match, including:

• Your personal and business credit ratings
• How long you've been in business
• Your annual business earnings
• The loan amount you want to take out
• The repayment terms you want to use

There are five options, the best of which for you will depend on the factors above.

1. A Credit Card

A business credit card with rewards could be the right choice for companies that want to be rewarded for purchasing their equipment. Business credit cards typically offer the lowest credit limits among the financing alternatives discussed here, with a credit limit of $100,000 in most cases. That isn't to say that when it comes to purchasing equipment, company owners should entirely disregard them.

2. Small Business Loans

This can be a great option for SBA-eligible companies that need less than $5.5 million in equipment financing. The SBA offers numerous lending programs for small business owners, including the CDC/504 Program, which may be used to finance equipment acquisitions. For-profit enterprises 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 get up to $5.5 million in finance, with up to 20 years loan durations. A personal guarantee is also required in addition to the equipment.

The current market rate for 5-year and 10-year US Treasury issues determines the interest rate for these loans. One of these loans currently has an effective rate of about 4.25 percent, which is lower than the rates associated with some of the other alternatives discussed here.

A fee of 3% of the loan amount will also be charged to business owners. The charge 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 choices. The different phases of the application and approval procedure and receiving the loan funds can take up to 8 weeks. If you need to buy equipment quickly, this is a big drawback.

3. Equipment Loans

This is often an excellent option for newer enterprises that seek to grow their operations and need equipment finance. The equipment serves as security for the loan, and up to 100% financing is feasible, however, some lenders may need a 20% down payment.

Depending on how much you borrow, repayment terms might be as little as 36 months or as long as ten years or more. Loan limits for equipment loans range with annual percentage rates of between 8% and 30%.

Equipment loans can often be approved in as little as two business days. Because many equipment loans and term loan companies primarily operate online and do not have a physical site, underwriting is sometimes considerably more simplified: Filling out an application, attaching documents like bank statements or tax records, and receiving an approval decision in as little as 24 hours.

With a typical bank, you may have to wait days, if not weeks, for your application to be processed. Obtaining an equipment loan does not require perfect credit, though lenders often need you to have been in business for at least one year before applying.

4. A Line of Credit

When a company needs quick, flexible, and ongoing access to equipment funding, a line of credit might be the best option. It 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 again. If you run a well-established company 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 five years. Funding can be completed in as little as a few days, and a poor credit score isn't usually a big stumbling barrier to acceptance. However, this means you'll have to pay more in interest.

When it comes to purchasing equipment, company lines of credit lose some of their shine compared to alternative financing options. Rates may easily be as high as 36%, which can quickly add up to a significant increase in the cost of your equipment. Because a company line of credit is intended to be used in the near term to address transitory cash flow gaps rather than big, one-time costs, it is not suitable for large, one-time expenses.

5. Short-Term Loans

A common choice for businesses with a steady stream of revenue and need to borrow up to $1 million, short-term loans offer immediate financing and are repaid over a fixed length of time. 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 could have to replace another business asset.

FAQs on Financing Equipment

Here are the most frequently asked questions when it comes to financing any sort of equipment to help add value to your business.

Q: What are the advantages of leasing equipment instead of buying it?

Leasing has a benefit over financing in that you are not making a down payment in order to receive the equipment, as you would be 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 simpler to qualify for a leasing agreement rather than financing.

Q: What are the disadvantages of leasing over buying equipment?

There is a possible disadvantage in terms of cost differences. You are not tied in as far as ownership when you lease equipment for a lengthy period of time, but you may wind up spending more to rent than you would if you bought the equipment instead.

Q: What are the disadvantages of short-term equipment financing loans?

These loan providers often have more stringent credit requirements compared to other lenders. For example, an equipment loan can be obtained with a credit score as low as 600. To qualify for a short-term loan, you will generally need 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.

Q: What are the advantages of short-term equipment financing loans?

While the approval criteria may appear to be more stringent, this might work in your favor if you can use a higher credit score to qualify for a cheaper interest rate. You could also be able to negotiate a reduced origination charge, 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.

Q: What are the advantages of using a credit card to finance new equipment?

The opportunity to earn points, cashback, or travel miles for your business is the major benefit of using a credit card for equipment. If you have a card that offers 3% cashback and use it to charge a $15,000 oven for your restaurant, for example, you will essentially be getting a $450 discount. That's something you won't find with any other type of finance.

Q: What are the disadvantages of using a credit card to finance new equipment?

The interest rates and fees are two of the major drawbacks. APRs on credit cards are frequently 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 might surpass the value of any incentives you get. Also, if you're dealing with an equipment seller who refuses to take credit card payments due to merchant costs, you could have problems. If the seller accepts credit cards, they may pass the cost on to you, making a credit card more costly than a term loan, for example.