Do you need updated equipment to keep operations running smoothly in your business? Depending on the type of equipment used in your business, it can be costly to acquire what you need. And in some cases, cash flow issues could arise if you have limited reserves.
Small business equipment financing may be a good option to help you acquire the equipment your company needs without emptying out cash reserves. Here’s an overview of how it works, what you need to qualify, the benefits and drawbacks of equipment financing, and how to find a reputable lender.
What Is Business Equipment Financing?
Equipment financing is a form of business financing that small business lenders offer to their clients. Instead of saving enough cash to buy equipment outright, you can borrow money from the bank to acquire the piece of equipment. You may have to put some of your money down, but the lender covers the majority of the purchase. Borrowers have to repay the lender over time with interest, usually through fixed monthly payments.
You can also lease equipment, so you don’t have to buy it outright, but equipment leases never give you full ownership of the equipment. Just like rent payments, leases never go away unless you give the equipment back to the lessor or you buy your own equipment. You may have higher monthly payments financing equipment than leasing it, but those monthly payments go away and can help small business owners save a lot of money in the long run.
For any equipment loan, the equipment becomes collateral. That means the lender can take the equipment if you fall behind on monthly loan payments. While this may sound intimidating, using equipment as collateral for the loan can increase your chances of getting approved and help you secure a lower interest rate.
Key Facts About Equipment Financing
- Buy New or Used Equipment: You’re not limited to a new piece of equipment with this form of funding. Some lenders also offer financing for used equipment purchases. However, the lender may give you capital equal to a lower percentage of the equipment’s face value if it is used. This decision helps the lender offset some of the risks to the borrower.
- Fund Up To 100% of Equipment Cost: Depending on the financing arrangement, you could be eligible to borrow up to 100 percent of the equipment’s purchase price. This means you won’t have to come out of pocket until it’s time to repay the loan. However, if you make a small down payment, you can reduce your monthly loan payments and reduce your interest payments over the loan’s lifetime.
- Equipment Act as Collateral for Loan: Equipment loans are secured, and the equipment acts as collateral. Consequently, the lender could seize the equipment if you fall behind on the loan payments.
- Terms Can Be From A Few Months To 10 years: You could get a repayment period of up to 10 years, which means you may not have to buy new equipment once it’s paid off if it has an extended useful life. A shorter loan term gets you out of debt sooner but increases your monthly payments. A longer loan term helps with cash flow, but you will pay more interest over the loan’s duration.
- Options Include a Loan or Lease: Some lenders also offer equipment leases instead of loans. This could be ideal if the equipment doesn’t have a long useful life, and you’d instead enter into a lease agreement to keep costs down, as it’s generally more affordable than buying the equipment outright. While leases can help for short-term obligations or new startups testing the waters, equipment financing makes more sense for long-term equipment.
How Can You Qualify for Business Equipment Financing?
Each lender has its own set of qualifications, but here are some general guidelines.
- Credit Score: Perfect credit isn’t required for business equipment financing, but a minimum FICO score between 550 and 600 is preferred. A higher credit score can help you get a lower interest rate and a higher loan amount. Many lenders will look at your personal credit, and some may also request your business credit score. It’s possible to get an equipment loan even if you have bad credit, but you may get stuck with a higher interest rate. Luckily, the payment activity on your small business equipment loan will improve your credit score, making it easier to get lower rates in the future.
- Time in Business: Ideally, you want to be in business for at least a year before applying for business equipment financing. Each lender has different requirements in this area, but more experience gives you more options.
- Personal and Business Finances: Most lenders will review your business’s bank statements and financial statements within the past three months. They may also have minimum annual revenue thresholds and analyze your personal financial statements to determine if you’re a good fit for financing. A financial institution or online lender may also request a copy of your business plan. Lenders may feel more confident giving you capital if they know how the small business equipment loan fits into your plan.
Should You Finance Your Business Equipment?
It could be sensible to finance your business equipment if you have a dire need and can’t afford to cover the costs upfront. Business equipment financing could also be ideal if you’d prefer holding onto equipment and stop making money payments instead of paying continuous lease payments. Equipment leasing can be beneficial if you only need equipment for a short period of time due to its brief lifespan, and it’s far too costly to keep buying and replacing it every few years. You should consider the pros and cons of equipment financing and leasing before making a decision.
Pros of Business Equipment Financing
- It can be a more affordable option if you get a secured equipment loan. These loans usually feature lower interest rates and more favorable loan terms.
- You’ll own the equipment at the end of the repayment period if you opt for a loan. That makes the monthly payments temporary instead of permanent, like with an equipment lease contract.
- There’s no additional collateral requirement as the lender uses the equipment to secure the loan.
- You may save at tax time if you can depreciate the equipment over its useful life. You should speak with a tax advisor before using depreciation to reduce your tax bill.
- You can avoid emptying your company’s cash reserves or creating cash flow issues by borrowing the funds instead of paying the entire purchase price upfront. Even if you have enough funds to buy equipment outright, it may not be a good idea to pursue that route.
- Equipment financing helps establish business credit for your company. Growing your business credit can help you get better loans in the future.
- Getting a fixed term means the monthly payments are consistent. They do not fluctuate like variable-rate loans.
- Acquire more assets for your business, some of which are necessary for your company to function properly.
Cons of Business Equipment Financing
- The equipment could be outdated at the end of the loan term. You would then have to buy new equipment. It’s easier to walk away from outdated equipment if you have a lease.
- You may have to make a down payment of up to 20 percent to secure equipment financing. Not every business has those funds readily available, but it’s more manageable than buying equipment outright. You may even find a lender who is willing to let you make a smaller down payment (or none at all).
- If you default on the terms of the financing arrangement, the lender could seize the equipment to recoup its losses. This can be a setback for your business if the equipment is critical for your company’s viability. However, you can refinance, work something out with the lender, or plan ahead with a longer loan term to mitigate this risk. Most lenders would prefer to work with you to find a solution than to have you default on the loan.
- Most lenders require you to be in business for at least a year to qualify for equipment financing, which means there are limited options for new companies. If you expand your search to equipment financing options from online lenders, you may find financing that you qualify for even if you only have a few months of business history.
- You may pay more each month for equipment financing than leasing in the short term. However, financing can save you a lot of money in the long run, especially if the equipment proves to be durable.
Other Financing Options to Consider
Before you consider an equipment loan for your company, it’s a good idea to compare financial products. Here are some of the different options you can use to fund your startup or business.
- Small business loan: An equipment loan is a type of small business loan. These loans usually feature competitive interest rates and fixed terms. You can get a variable interest rate if you prefer, but many borrowers opt for a fixed term to ensure monthly payments stay the same.
- Working capital loan: This financial product helps business owners address short-term expenses. These loan options are similar to small business loans but usually, have shorter terms.
- Business lines of credit: Credit lines provide extra reserves in case you need them. Some business owners use business lines of credit before they may have lower credit score requirements than small business loans. The added benefit is that you only pay interest when you borrow against the credit line. Some people never use these financial products but keep them for emergencies.
- Credit cards: A business credit card is a type of credit line. However, these cards usually come with rewards programs for every business expense, such as cashback or reward points. The rewards can help you save money, and most credit card companies provide reports on your spending. Those reports can help during tax season.
- Commercial Real Estate Loan: This financial product helps small business owners acquire commercial properties. A property can help you reach new customers and establish a local footprint for your company.
- Merchant cash advances: This funding source relies on credit and debit card transactions from customers to repay the balance. These advances can get expensive in a hurry due to higher interest rates, but they have very low credit score requirements.
Any loan can improve your credit history. Most lenders report your payment history to the major credit bureaus. These financial products and equipment loans can help you get lower interest rates on future capital.
Where Can You Get Business Equipment Financing?
SBA Lenders
SBA (Small Business Administration)-approved lenders offer business equipment loans with low-interest rates and terms of up to 10 years. You’ll need a credit score of at least 690 to qualify in most cases, and you can use existing equipment or the equipment you’re purchasing as collateral to secure the SBA loan. The SBA is the golden standard, but it will take over a month to receive funding in most cases.
Many banks, credit unions, and online lenders offer SBA-backed loans. However, small business owners who need quicker financing should look for another type of loan. It’s also important to consider the credit score requirement, as some service providers that offer SBA-backed loans may also provide alternative financing with lower requirements.
Banks and Credit Unions
If you have good or excellent credit, you could qualify for an equipment loan with competitive terms through a traditional lender, like a bank or credit union. However, be mindful that you’ll need more than one year of business experience and a consistent revenue stream.
Even if you have an excellent credit score, financial institutions may not be the right fit for your financial needs. One of the weaknesses these institutions have is how long the entire process takes. It can take weeks for some banks and credit unions to process your application, provide a decision, and make the funds available in your bank account. These institutions are also less forgiving for small business owners and medium-sized businesses that do not have good credit scores.
Online Lenders
You’ll generally find that business equipment financing is easier to qualify for through online lenders than banks, credit unions and SBA lenders. Even if you haven’t been in business long or have less-than-perfect credit, you could still get approved for funding and possibly receive the loan proceeds in as little as 24 hours. Online lenders also tend to have more versatility than banks and credit unions. They offer more financial products to make capital more accessible to every small business owner.
