Whether you’re running a million-dollar enterprise or just starting out, it’s likely that at least one piece of equipment plays an integral role in how your business functions. If you can’t pay for equipment out of pocket, your best option may be to seek equipment financing.
Here is everything you need to know about equipment financing to decide if it fits your business needs.
What is Equipment Financing?
Equipment financing is a type of loan intended for the purchase of business-related equipment. Like most other loan offerings, equipment financing comes with regular payments, including principal and interest, over a specified duration. Equipment financing lenders often offer a variety repayment options to cater to different borrowers.
The best way to understand equipment financing is by looking at a physical asset. This could be anything from computers and smartphones to trucks and trailers. Unlike a working capital loan, the asset you’re purchasing serves as its own collateral. For this reason, equipment financing tends to be a more cost-effective and lower-risk way to acquire equipment than other forms of financing.
How Does Equipment Financing Work?
It’s important that before contacting your financer you have an idea of exactly what you are looking to buy. You’ll also want an idea of who you’re planning to buy it from. In most cases, your equipment financer is covering either all or a percentage of the cost of your equipment and will directly pay the vendor for the equipment without the money ever entering your bank account.
The length of time your equipment is financed for will vary depending on what type you choose, but it’s usually anywhere between two and seven years. Over that time, you’ll typically make monthly payments to your equipment financer, paying off the principal plus interest.
Loaning and Leasing
There are two common ways to finance equipment: through a loan or a lease. While both give you access to the equipment needed to run your business, there are many differences between the two methods.
Equipment Loan
Equipment loans are taken out to purchase equipment, with the express purpose being that you will soon be purchasing it. Typically, the equipment secures the loan — if you can no longer afford to pay the loan, the equipment gets collected as collateral.
For business owners who can’t afford to make the purchase outright, these loans are a great option. They allow you access and control of an expensive piece of equipment long-term without having heavy debt load on your company’s bottom line. A lending institution might agree to extend most of the capital so that you can pay in periodic increments.
Equipment Lease
Leasing may be the perfect solution for you if your company needs to replace equipment often or doesn’t have enough capital available. It’s also more likely to cover additional soft costs associated with shipping and installing the equipment. Instead of borrowing money to purchase the equipment, you’re paying a fee to borrow the equipment. The leasing company technically maintains ownership of the equipment but lets you use it. To keep up with the latest trends and technology, many companies lease their equipment instead of buying it. This allows them more freedom to upgrade as needed or when newer models are released.
The two major types of leases are finance and operating. A finance lease functions a bit like a loan alternative and is used to finance the equipment you want to own long term. An operating lease is closer to a rental agreement that returns the equipment to the lending company at the end of the lease. Both types have many variations. Here are a few common types:
- Fair Market Value Lease – you make regular payments while borrowing the equipment for a set term. When the term is up, you have the option of returning the equipment or purchasing it at its fair market value.
- $1 Buyout Lease – you’ll pay off the cost of the equipment, plus interest, over the course of the lease. In the end, you’ll owe exactly $1. Once you pay this residual, which is little more than a formality, you’ll fully own the equipment. Aside from technical differences, this type of lease is very similar to a loan in terms of structure and cost.
- 10% Option Lease: This lease is the same as a $1 lease, but at the end of the term, you have the option of purchasing the equipment for 10% of its costs. These tend to carry lower monthly payments than a $1 buyout lease.
Applying and Planning
Before you seek out a loan, it will help to know a few simple answers to clarify your equipment loan needs:
- What equipment do you need and is it essential to business operations?
- Do you want to purchase new or used equipment?
- How much monthly revenue do you have, or do you anticipate?
- Will this equipment help increase revenue? By how much?
- How much cash flow do you have to pay loan installments?
- Do you have cash reserves and if so, how much?
By answering these questions, you now have a clear idea of what you need / can afford and are ready to speak with lenders.
In your journey to find the perfect lender, consider iBank Corp. Our fast business loans application process is easy and only takes about 15 minutes. You’ll sign documents electronically and receive your working capital funds directly to your business checking account in as little as 48 hours.
Advantages of Equipment Financing
As a self-secure loan, the following are the advantages of equipment financing:
- Lenders can ease eligibility requirements.
- Different repayment options are often available.
- Up to 100% of equipment financing options are available.
- Repayment terms are flexible and can be amortized throughout the lifetime of the equipment.
- Full ownership of the equipment after the loan has been repaid.
- The equipment itself will serve as collateral.
- The application process is relatively simple with quick access to financing.
- Lower tax burden.
- Resolves cash flow issues.
- Improves personal and business credit scores.
Disadvantages of Equipment Financing
The following are a few disadvantages of using equipment financing:
- Interest rates can cause equipment financing to be more expensive compared to buying in cash.
- For equipment that can depreciate quickly, like computers and software, it may be better to use equipment leasing rather than financing.
- You are responsible for all repair and maintenance and repair costs unless you lease the equipment.
- Equipment loans can only be used for equipment.
- Depreciation-related tax deductions will likely prevent you from deducting the full cost of the equipment each year.
- Often the equipment itself is used as collateral, however a lender may need additional collateral such as other business assets or they may request a personal guarantee.
Is Equipment Financing Right for You?
When applying for an equipment loan, there are several factors that go into loan approval, including the amount borrowed, interest rate, and term length. The amount of money you’ll be eligible to borrow depends on the type of equipment you’re purchasing, whether its new or used, and your credit history.
Unlike many other types of financing, equipment loans are meant for a particular purpose. While that prevents these loans from being versatile, for the right person, equipment loans can be highly effective. You can’t decide what is best for your business without conducting some research, understanding your needs, and determining the type of equipment your business requires. A lot goes into this process, make sure you have all the information to make the best decision.
Use these basics to get the most out of equipment financing and avoid potential pitfalls. And remember, the professionals at iBank Corp are ready and waiting to evaluate your needs and provide you with the right options for your business.