Equipment Financing: How Does It Work?

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If you're a small business owner you understand how important it is to quickly and economically obtain, upgrade or replace the equipment needed to perform your daily tasks. Purchasing equipment outright can put substantial strain on your cash flow. Equipment financing may be the ideal solution to keep your business functioning at optimal performance or to expand to meet increasing demand. The following will provide an overview of how equipment financing works, what rates and terms you can expect in today’s marketplace, what are the basic qualifications for these loans, and where you can obtain such a loan.

How Does Equipment Financing Work?

Equipment financing refers to a loan used to purchase business-related equipment, such as a restaurant oven, a vehicle or a copier scanner. Equipment loans provide for periodic payments that include interest and principal over a fixed term. As security for the loan, the lender may require a lien on the equipment as collateral against your debt. Once the loan is paid in full, you own the equipment free of any lien. The structure of an equipment loan may also impose a lien upon additional business assets or require a personal guarantee. Failure to pay your loan may result in the repossession of your business assets or your personal assets—in the case of a personal guarantee. A careful review of the loan terms is vital to understanding your risk.

For example, if you are opening up a restaurant you will need a significant amount of equipment, including a commercial range, ovens and a refrigerator. Let’s say the equipment costs total $75,000. You apply and are approved for an equipment loan equal to 80% of the equipment’s cost, or $61,500. That means your out of pocket expenses will be $13,500, and you can retain $61,500 in your cash reserves to offset all the other costs associated with a new business including the cost of the space, marketing and advertising, and permits and licenses.

Equipment financing is distinct from equipment leasing, wherein you pay the owner of the equipment periodic rent for use of the equipment over an agreed-upon period of time. At the end of the leasing term, unless you agree with the owner on renewal terms or a buyout, the equipment is returned to the owner. Generally, the qualifications for leasing are less stringent than for financing; however, if the equipment is necessary to your business, the endless payments on leased equipment without the prospect of future outright ownership may prove a more costly option.

Equipment Financing Rates and Terms

As with all financing, rates and terms will vary depending on an applicant’s qualifications and current market conditions. The below are some sample rates and terms you can expect when shopping for an equipment loan.

Loan to Value RatioUp to 100%
Fixed Interest Rates4.00% - 12.75%
Repayment TermsSeveral months up to 10 years or more
Funding SpeedAs little as 2 business days
Other RequirementsMay have minimum credit score or operating history requirements.

Qualifying for an Equipment Loan

Lenders will vary in their requirements to obtain an equipment loan. The following are general qualifications a lender will look at when making a credit decision; however, underwriting standards vary and should be vetted before choosing a lender to ensure you meet their minimum requirements.

Your personal credit score will be an important factor in obtaining an equipment loan. If you are unsure of your current credit score, you can find your credit rating online. The higher your score, the more likely you are to get approved and the better loan terms you can anticipate.

In addition to credit score, lenders may require a business plan that describes your business and a detailed proposal for future growth. The basic goal is to give prospective lenders a comprehensive summary of your business. The number of years you've been in business and the annual revenue of your enterprise are important factors to include within your business plan. Some lenders may have thresholds requirements in this regard such as a minimum of two years in business with annual revenues of over $250,000.

Beyond a statement of revenues within your business plan, and a profit and loss statement, lenders' applications may require a balance sheet or cash flow statement. These should identify the revenue coming in to the business and the expenses going out. These statements help lenders assess the financial strength of your business. Since lenders are also interested in the personal finances of a small business owner, personal financial statements should be prepared as well. Preparation of all pertinent application documentation is important to help expedite the process. Hiring a qualified accountant in anticipation of applying for an equipment loan is advisable to ensure your finances are in order.

Where to Get Equipment Financing

There are several options available in the marketplace for obtaining equipment financing. Equipment loans can be obtained from sources ranging from traditional national lenders to smaller specialized online lenders. Traditional national lenders, like Wells Fargo and Bank of America, generally have stricter underwriting requirements, but better rates and terms. They may be more suitable to established businesses with strong cash flow and assets. Specialized online lenders, like Currency, tend to be more flexible with their underwriting requirements. However, the rates and terms will be less favorable. This type of lender is more suitable to startups or businesses that do not meet the minimum credit and asset requirements of national lenders. The option you choose will depend upon the qualifications of your business as well as the loan type that best suits your needs.

In addition to an equipment loan, small business owners can also consider obtaining the money needed to purchase equipment via a business credit card, invoice financing or factoring, or angel investing. Each have their pros and cons regarding terms, turnaround time and qualification requirements.

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