Equipment financing allows businesses to borrow funds to purchase needed equipment.
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From commercial ovens to forklifts or office fixtures, businesses rely on a wide variety of equipment to operate. Although purchasing equipment outright is an option, this can be prohibitively expensive. Equipment financing gives businesses the option to purchase equipment and pay off the cost over time.
What is equipment financing?
Equipment financing is a common type of loan that allows businesses to borrow funds to purchase equipment. When you need to purchase new equipment or replace or upgrade old equipment, paying the entire cost upfront could put a major strain on your finances. Similar to a car loan, equipment financing can be used to purchase new or used equipment and will be paid off in installments over time, with added interest.
Although you can purchase equipment using funds from other types of business loans, if your company needs to buy equipment, equipment financing is likely to be easier to get and provides the most favorable terms for that purpose. Equipment financing has fixed interest rates, meaning that you will always know how much your monthly payment will be, and loan terms are typically longer, making payments more manageable.
How does equipment financing work?
When you finance equipment, the item itself typically serves as collateral. This means that if you are unable to pay your loan, the lender can repossess your equipment. Typically, no additional collateral or personal guarantee is required, although some loans may require additional liens or personal guarantees. Because the asset being financed is the collateral, the loan is lower risk for the lender, which means it can be easier for newer businesses to qualify for equipment financing than other types of loans, such as a term loan or business line of credit.
Equipment financing can be obtained for amounts as low as $1,000 to as much as $5 million or more. Loan terms can range from one to 10 years, depending on the type of equipment. The length of the loan term should not be longer than the amount of time you expect to use the equipment; otherwise you could still be paying off the loan after the equipment has reached the end of its useful life. However, a term that is too short can result in high monthly payments that could be financially burdensome. Once you have paid off the full loan amount, you will own the equipment.
It’s possible to finance up to 100 percent of the cost of equipment, but it’s common for lenders to require you to pay 10 to 25 percent of the cost of the item as a down payment. Interest rates are generally lower if you are able to pay a larger down payment. Interest rates can vary, but are often between four and 30 percent.
What can equipment financing be used for?
Equipment financing can be used for many types of equipment. Some common types of equipment that can be financed include:
- Restaurant equipment such as ovens, stoves, refrigerators, freezers, or deep fryers
- Manufacturing equipment
- Heavy duty trucks
- Construction equipment
- Medical equipment
- Office items such as cubicles, furniture, or computers
- Payment software or hardware
Where can you get equipment financing?
Equipment financing is available from traditional banks and credit unions, as well as online lenders. Equipment financing terms and requirements can vary depending on your industry and the type of equipment you are seeking. You will need to find a lender that finances the type of equipment you need.
Typically, traditional banks require stricter qualifications but offer more favorable terms and interest rates, while online lenders may be able to provide funds more quickly and loan to newer or less established businesses but may have higher interest rates and fees.
Some online lenders offer other types of loans that can be used for equipment, while others offer true equipment financing or focus specifically on equipment loans. It’s important to carefully evaluate the financing options you are offered to make sure you understand what loan you are getting.
How can you qualify for equipment financing?
When qualifying for a loan, lenders typically look at your business and personal credit scores, business plan, revenue, and number of years in business. You will likely need to provide your lender with profit and loss statements, cash flow information, and personal financial statements. Businesses with high credit scores and a strong financial history will typically receive better loan loan terms.
It is usually easier to be qualified for equipment financing than for other types of business loans because the equipment itself serves as collateral, meaning that the lender can be fairly confident that costs could be recouped if the borrower fails to pay the loan.
Requirements vary depending on the lender, but it’s common for companies to be required to have been in business for a minimum of one to two years, and have a credit score above 600. Some lenders may require you to have revenue above a certain amount. Online lenders may be more flexible in their requirements, allowing newer businesses and those with lower credit scores to receive funding.
What are the advantages of equipment financing?
There are a number of advantages to equipment financing.
- They are easier to qualify for. Compared to other types of business loans, equipment financing typically has lower credit score requirements and can accept newer businesses with less established financial histories.
- Interest rates are lower. Equipment financing generally offers lower interest rates than other types of financing or loans.
- They don’t require additional collateral. The equipment itself is usually the collateral for equipment financing, meaning that you will likely not need to provide additional collateral or guarantees.
- They allow you to get funding quickly. The application process for equipment loans is fairly straightforward and applications can often be approved quickly.
- You will own the equipment after the loan is paid off.
- Interest on equipment financing is tax deductible.
What are the disadvantages of equipment financing?
Equipment financing has a few disadvantages.
- Funds are limited to equipment purchases. Unlike other types of loans, which allow you more flexibility in how you can make use of borrowed funds, equipment financing is strictly limited to equipment purchasing.
- Loans may require large down payments. Most equipment financing loans require you to pay 10 to 25 percent of the loan amount as a down payment. Some businesses may not be able to afford the down payment for expensive equipment.
- Equipment could become outdated before you finish paying off the loan. Selling or discarding outdated equipment can be inconvenient.
Equipment Financing vs. Equipment Leasing
Equipment leasing is a common alternative to equipment financing. When you lease equipment, the leasing company owns the equipment and you pay to use it.
Equipment leases typically have a fixed interest rate and last for a fixed term, meaning your payments will always be the same. Interest rates and fees will vary, and as with equipment financing, lenders will evaluate your personal and business credit scores to determine your rates. Equipment leases may be available from the same lenders that offer equipment financing or may be offered by the equipment manufacturer or distributor.
When is equipment leasing a good idea?
Equipment leasing may be a wise choice if your equipment will become less valuable over a shorter period of time due to heavy wear and tear or rapid changes in technology. If you frequently need to update your equipment, leasing can be helpful.
Rather than reselling or disposing of the old equipment, you can simply return the equipment when the lease term is finished and obtain a new lease for updated equipment, if desired. In addition, some leasing companies will allow you to purchase the equipment at the end of your lease, either for fair market value or for a predetermined cost.
Some companies are unable to afford the down payment typically required when financing equipment; since equipment leases do not require down payments, a lease could be the only choice in this situation.
It’s important to be aware that leases end up being more expensive than equipment financing over longer time periods. If you expect to use the equipment for more than three years, equipment financing will likely be more cost-effective. Leases may offer lower monthly payments than loans, but they may have higher interest rates.
If you choose a lease, it’s crucial that your lease term matches the expected useful life of your equipment. If the equipment becomes obsolete before the lease term ends, you would still have to pay for your lease until the end of the term.
If your business needs to purchase equipment, financing it could be a good choice. Equipment financing can help you pay for large equipment purchases over time, rather than having the cash available upfront. Compared to other types of loans, equipment financing can be easier to obtain and have more favorable terms, which could be helpful to new business owners who are just starting out. Equipment leasing is another option that could be best for equipment that will need to be replaced frequently.