What Is Equipment Financing?
Equipment financing, also called an equipment loan, is a type of small business loan designed for the purpose of buying machinery or vehicles. It provides small business owners capital to purchase new or used equipment needed to run their companies. You can take out equipment loans for a wide array of purchases, such as medical equipment, farm vehicles, or computer equipment.
The process to get an equipment loan is quick. Both traditional banks and online lenders offer this loan option. But although banks generally offer more favorable interest rates and terms, they also have strict credit requirements.
The amount you qualify for will depend on the purchase price of the machinery, but you might be able to finance up to 100% of the equipment's value. The length of the loan term will also depend on the expected life of the equipment.
With equipment financing, the machinery you’re purchasing serves as collateral for the loan. This means the lender can seize it if you fail to repay the loan. Some lenders may also require a personal guarantee, or they may use a blanket lien to lay claim on your assets in case you default.
This is why it’s important to understand the rules of your contract no matter what type of financing you’re getting into. Make sure you know the penalties in place in case you can’t fulfill your obligations.
What Can You Use Equipment Financing for?
You can use equipment financing to buy or lease any new or used equipment you need to operate your business. The lender will loan you a percentage of the full value of the piece of equipment. Once you’ve paid off your loan, you own the machinery free and clear.
Most small business owners take out equipment loans to purchase specialized machinery, like tractors, X-ray machines, and delivery trucks. Businesses may also use equipment financing to acquire intangible assets, like business-related software.
Here are some common uses for equipment financing:
- Restaurant needs, such as industrial ovens
- Health care equipment
- Office furniture and supplies
- Heavy equipment
- Manufacturing machinery and parts
- Construction equipment
- Farming equipment
- Vehicles and other transportation needs
- Project management software and similar technology
- HVAC units
How Is Equipment Financing Different From Leasing?
The main difference between equipment financing and leasing is who owns it. When you lease, you pay the vendor for the privilege of using the equipment for the duration of the lease term. You don’t own the asset and you return it at the end of the term.
On the other hand, equipment loans allow you to purchase the piece of equipment outright with the machinery itself as collateral. Once you’ve paid off your loan, you own the equipment free and clear.
Leasing a piece of equipment is comparable to renting an apartment, while equipment financing can be compared to buying a house with a mortgage. Some reasons small business owners lease equipment include:
- The requirements for leasing are less strict and the application process is more straightforward than for financing.
- Leasing doesn’t require any money down or additional collateral, which means there’s no cash outlay for the business to acquire the asset. It also doesn’t risk any personal or business assets to secure the lease agreement.
- Since you’re renting the equipment, the vendor or the leasing company is responsible for any repairs or replacements if the equipment breaks down.
- Leasing agreements can be flexible — you can decide to renew the lease, return the equipment, or buy it.
- At the end of a lease term, you also have the option to lease a new, updated version of the equipment. This is a significant advantage for equipment like computers, which can quickly become outdated.
The biggest drawback of leasing is, of course, the cost. A business can reduce its business expense during the initial term of the lease because it doesn’t need a deposit or down payment. However, it may not be cost-effective for your business to pay monthly interest without the prospect of owning the equipment. This is especially true if the equipment is essential to the operations of your business.
For instance, if you own a bakery and need an industrial oven to make your products, renting the equipment long term may cost you more money than buying it outright. This is why it’s recommended that you consider leasing pieces of equipment if you’ll only need them for 36 months or less. For machinery you’ll use for as long as you’re in business, it’s a smarter move to buy them outright, and you can utilize equipment financing if you need it.
How Does Equipment Financing Work?
Equipment financing is a loan that a business owner takes out to purchase equipment necessary to run their business. Commercial and industrial equipment are typically expensive, which means a huge expense for companies. However, most small businesses don’t have the working capital to buy business-related equipment outright, so they use equipment financing.
If you’ve ever had a car loan before, you’re already familiar with the overall structure of an equipment loan. The total amount you borrow depends on the type of equipment you need to purchase and whether it’s new or pre-owned. Since the funding is secured with the equipment itself, there are no additional collateral requirements to get approved by a lender.
In this type of financing, you get approved for a loan amount depending on the equipment’s value or purchase price. Then, you make loan payments that include interest and principal over a fixed term. Most equipment financing interest rates are fixed with monthly payment terms.
As for the loan term, it varies depending on the life of the machinery. It’s recommended that you choose a repayment term that’s close to how long you expect to use the equipment. For instance, if you’re buying an oven for your bakery that you expect to use for seven years, you should get a seven-year term.
This is because if you agree to a shorter loan term, you might have to pay large monthly installments that cost more than you can afford. If you take out a long-term loan, however, you could be paying for the equipment even after you’ve stopped using it. A longer term than necessary also means more interest payments.
When Does It Make Sense to Use Equipment Financing?
For business owners in many industries, growth is a direct result of purchasing more equipment. The health care, transportation, and manufacturing industries are business models where growth is achieved through the number of vehicles or machines operating at any time.
What if your plans for growth are more extensive than what your current cash flow allows? How can you afford to buy the needed equipment to reach your goals? Fortunately, that’s where equipment financing options come to the rescue. Equipment loans provide the working capital needed to take your business to the next level. For instance, if you’re opening a bakery, you may need to rent a space for a storefront and a number of big-ticket items.
You’ll need industrial convection ovens, heavy-duty mixers, refrigerators, and display cases, among other things. Let’s say the total cost of appliances you need is $60,000. You can apply for an equipment loan and get credit approval for as much as 100% of the total value of the kitchen appliances.
If you can get the full $60,000 as an equipment loan, it means you won’t have to shell out any cash for your equipment needs and you can use your available capital to pay for rent, wages, supplies, and other operating expenses.
How to Qualify for Equipment Financing
How much you can qualify for and the APR you’ll get from a lender depends on three factors:
Value of the Equipment
Lenders consider the value of the equipment as an essential factor for equipment loans because the amount you can get approved for depends on it. They also consider the condition and resale value of the equipment since it serves as collateral for the loan. So, lenders use the equipment’s initial and resale value to determine how much money they’re willing to loan you.
Your Company’s Financial History
Another critical factor that affects how much you can get approved for is your company’s financial history. Lenders will be looking at the number of years you’ve been in business and the amount of monthly or annual revenue you bring in. This lets them know you can pay your monthly installments without difficulty.
For this, you might be asked to provide a business plan describing how the equipment can help increase your revenue or grow your company. You may also need to provide income statements, balance sheets, and cash flow statements for your business — all of which help lenders assess the financial health of your company.
Your Credit Score
Your personal and business credit scores are always an important factor in obtaining any type of business loan. As a business owner, make sure to track your credit scores from the three major credit reporting agencies: Equifax, Experian, and TransUnion. Even though you can get approved for equipment financing with poor or bad credit, a higher credit rating gets you better interest rates or loan terms.
If you’re unsure of your current credit score, get your free annual credit report from AnnualCreditReport.com. If you’re a new business, you might not have a business credit score yet. If you’re fairly established, you can check your score with Experian, Equifax, and Dun & Bradstreet. The rating ranges from 0 to 100.
Remember that these are minimum requirements. You might be asked for additional forms of identification — such as an ID, employer identification number (EIN), or Social Security number (SSN) — or documentation like your business license, a “doing business as” (DBA) certification, or an operating agreement for your business.
Some lenders may also want to know the state of your personal finances. This means you may need to declare your personal debts and submit tax returns or bank statements.
How Hard Is It to Get Equipment Financing?
Business equipment financing can be one of the easiest types of loans to qualify for. Since the equipment serves as collateral to secure the loan, the minimum credit rating for approval is 550. Lenders make credit decisions based on the resale value of the equipment. They also make sure your business is making enough money to make the monthly payments.
At Clarify Capital, we work with more than 75 lenders to help you find the best rate and lender for your equipment purchases. This means a down payment isn’t typically required, so you can receive funding without making a deposit upfront. If your equipment loan application is approved, you can receive up to 100% of the total cost of the equipment.
Secure Equipment Financing for Your Business Today
Starting a business is a huge accomplishment. To stay in business, you need to be able to ebb and flow through the seasons of highs and lows. Most importantly, your business should be continuously growing.
The only way you can acquire and retain customers is by expanding your operations when you need to. If you’re constantly late on orders because you only have one machine, you may lose customers. Thankfully, there are financing options available to help you grow your company.
Clarify Capital works with 75-plus lenders to help you find the best rates. If you’re looking for quick processing and approval, we can help you find an equipment loan and lender best suited to your needs. Your dedicated advisor will work with you through the process.
This is part of our promise to keep things simple, convenient, and transparent. Apply online or speak to us directly by calling (877) 838-3919 and let us help you take your business to the next level.