Equipment Loans: What They Are, How They Work, & 5 Ways To Get One For Your Small Business
Whether you’re paving a road or writing software, sooner or later you’re going to need to buy, upgrade, or replace your business-related equipment. Unless you’re lucky enough to have a lot of cash on hand, the costs of doing so out of pocket may prove prohibitive. If you don’t have the luxury of waiting, you’ll need to seek financing. When that happens, you should consider an equipment loan.
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What Is An Equipment Loan?
An equipment loan is a secured installment loan designed specifically for the acquisition of, well, equipment. Equipment can be defined fairly loosely here, but it almost all cases it describes some kind of tangible asset used in your business operations. These are things like vehicles, machines, computers, appliances, and furniture. It does not typically include debt servicing, labor expenses, real estate, buildings, etc.
How Equipment Loans Work
On the surface, equipment loans are a lot like any other kind of medium-to-long-term installment loan. If you successfully apply, you’ll receive a lump sum of money. Your loan will accumulate interest over time at either fixed or variable rates, and you’ll make regular payments over the loan’s term. In the case of equipment loans, this is usually a monthly payment.
It’s typical for equipment loans to require a down payment; you should generally expect to pay around 15% of the cost of the equipment out of pocket. In most cases, delivery and shipment of the equipment is not included. There are, however, exceptions to these rules if you’re determined enough to find them.
So why would you want an equipment loan over another type of financing? Equipment loans have a nifty feature built into them that reduces risk to both the lender and the borrower, which in turn means better rates and terms on average. Normally if you want a secured loan, you have to put up collateral — property, a cash deposit, etc. — as security for the loan. The lender can then repossess your collateral if you default. With equipment loans, the equipment you purchase with the loan becomes the collateral. If you default, the lender collects the equipment and resells it and you don’t have to worry about them coming after your house.
You’ll generally want to know what equipment you’re planning to buy when you apply for the loan, including the vendor you’re planning to buy it from. Depending on the lender, the money may or may not be paid directly to the vendor instead of passing through you
Equipment Lines Of Credit
One variation on the equipment loan you may come across is the equipment line of credit. The purpose of an equipment line of credit is identical to that of an equipment loan, it just provides you a bit more leeway.
An equipment line of credit is a non-revolving line of credit extended to a borrower to purchase equipment. Instead of approving you for a specific purchase, it grants you a credit limit that you can draw on to buy items within an approved window of time. They’re a little more flexible in that you don’t necessarily need to know exactly what model and vendor you’re choosing when you apply for the loan.
After you’ve made your purchases and/or the buying window expires, an equipment line of credit will effectively become an equipment loan, accruing interest over time.
Equipment Loans VS Equipment Leases
Loans aren’t the only way to finance equipment. Turns out there’s a whole other genre of financial products designed to do that: leases. Traditionally, leasing meant something like “renting,” but in today’s equipment financing world it covers arrangements ranging from rentals to “equipment financing agreements” that are effectively used to buy the equipment rather than rent it, to contracts that allow you to rent with the option to buy.
In most cases, an equipment loan will have a lower rate than a similar equipment lease, but leases can accommodate a greater variety of circumstances than a loan. If the equipment you need quickly becomes outdated, a lease may be a smarter option, for example.
If you want a deeper dive into the differences and similarities, check out our Equipment Financing: Lease VS Loan article.
5 Ways To Get An Equipment Loan
Now let’s take a look at where you can go to get an equipment loan.
1. Check With Your Bank Or Credit Union
When you’re looking for financing, your first stop should usually be the institutions you deal with on a regular basis. If they make a habit of working with small businesses, they may offer specialized financial services for certain types of equipment.
The advantage of dealing with your local financial institution is that you’ve probably already developed a working relationship with them, even if all you have are basic savings and checking accounts. Since finance is largely about managing risk, the fact that you’re a known quantity to the bank can translate to better rates.
Of course, if you’re frequently overdrafting or have cash flow issues, being known can backfire on you.
2. Use An Online Lender
While many online lenders specialize in short-term working capital loans, there are a decent number that offer equipment financing, including equipment loans. A few even specialize in equipment financing.
These companies frequently cultivate relationships with vendors and manufacturers, allowing them to — in theory — offer competitive rates on new and used equipment if you don’t mind buying directly from the lender.
3. See If The Vendor Offers Financing
After the financial crash, credit was hard to come by for many individuals and small businesses. While banks can afford to be conservative with their lending, equipment manufacturers don’t have that luxury. If they don’t make sales, they don’t make money.
As it happens, many of these manufacturers directly offer financing. Companies like General Motors have dedicated financing divisions that offer leases and loans through their dealers.
4. Get An SBA Loan
The Small Business Administration (SBA) guarantees loans offered by approved lenders (a bank, for example), allowing qualifying borrowers to access better rates and terms than they would normally be able to. Both SBA 7(a) and 504 loans can be used for equipment purchases. The 504 loan is, in most cases, the preferred type for large machinery purchases, but the more flexible SBA 7(a) loan is a perfectly reasonable option for buying equipment.
Just be ready for a longer and more involved application process if you decide to go this route.
5. Consider An Equipment Financing Agreement (EFA)
If you need equipment fast, traditional equipment loans aren’t your only option. Depending on the circumstances, they may not even be your best option. If a traditional equipment loan proves elusive, there are alternatives.
One of the more common ones is the EFA. An EFA is sort of a hybrid loan-lease. The language of the agreement is very similar to that of a lease: you’ll still be making monthly payments, your down payment will probably be the first and last month’s payment, and no collateral will be necessary. The agreement, however, is between a lender and a borrower rather than a lessor and a lessee. What this means, in practice, is that you’re getting a $1 buyout lease that absolves the lender of any liability they have for maintaining and repairing the equipment.
FAQs About Equipment Loans
What Should I Consider When Looking For An Equipment Loan?
The key things you should consider are:
- Will the lender finance my type of equipment?
- How much of a down payment am I expected to make?
- What is the APR of the loan?
- How long will I have to pay it off?
How Difficult Is It To Get An Equipment Loan?
The better-than-typical rates and terms that come with equipment loans also tend to come with higher qualifications. Most equipment lenders will want to work with a company that’s been in business for a few years, preferably one with good credit. As with everything financial, there are always exceptions, however. Just be prepared to have to search harder to find a lender willing to work with you.
Alternately, you can look into leasing your equipment, as lessors usually have less stringent qualifications.
How Long Does It Take To Get An Equipment Loan?
As loans go, equipment loans tend to be on the fast side. Depending on the lender you go through, you’re looking at somewhere between a couple of days to a week or two. The exception is SBA loans, which usually takes between two to three months.
How Much Do Equipment Loans Usually Cost?
Equipment loan rates can vary extremely widely, from around 3-4% on the low end and topping out somewhere around 20%. As is usually the case with loans, the better your credit, the more likely your rate will be on the low side.
Can I Get An Equipment Loan Without Putting Money Down?
There are equipment loan providers that offer 100% financing, but you should expect higher rates for the privilege.
If you’re willing to think outside the box and investigate some of the avenues discussed above, you should be able to find financing that meets your needs and circumstances. If you want a head start, check out some of our favorite equipment financing companies.