Heavy Equipment Finance Basics: What You Should Know About Small Business Heavy Equipment Loans & Leases
Businesses that rely on heavy equipment to carry out their day-to-day operations face some serious costs when it comes to acquiring, upgrading, or replacing their equipment. These large machines can be difficult to finance out of pocket, and even if you can, it may not be the most pragmatic way to do so.
Below, we’ll dive into some of the heavy equipment financing basics and cover what you should know about small business heavy equipment loans and leases.
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What Is Heavy Equipment Financing?
Heavy equipment financing includes loans and leases used to acquire specialized vehicles, such as dump trucks, backhoes, and bulldozers, that are used in construction, excavation, or timber projects.
There are several different ways to go about financing heavy equipment, depending on whether you’d prefer to own the heavy equipment or simply operate it for a set period. Each has its advantages and disadvantages.
What Is Heavy Equipment?
While the phrase “heavy equipment” is most often associated with construction projects, it encompasses a wide variety of specialized vehicles controlled by licensed operators. Common examples of heavy equipment include:
- Dump trucks
- Street sweepers
- Pile drivers
- Tunnel boring machines
Heavy Equipment Loans VS Leases
The most commons types of heavy equipment financing are loans and leases. At a glance, they share a lot of traits in common: term lengths, interest rates, monthly payments. They do, however, have different rationales and rules governing them.
An equipment loan is a term loan used, as you might guess, to buy equipment. Most equipment loans last between three to seven years, with some lasting as long as 10. In most cases, you’ll be expected to make a down payment of somewhere around 15% of the cost of the equipment. Relative to leases, loans usually have better rates but cover a smaller percentage of the total costs.
An equipment lease is used to buy or rent equipment. Leases themselves fall into two broad categories: capital leases and operating leases.
Capital leases are used to buy equipment and serve many of the same functions as an equipment loan. They don’t typically require a down payment and often cover 100% of the costs, with terms typically ranging from three to five years. Heavy equipment capital leases frequently come in the form of $1 buyout leases or 10% purchase option leases (10% PUT). This means that, at the end of your leasing term, you’ll have the option to buy your equipment for the amount specified: $1 in the case of $1 buyouts, and 10% of the equipment’s cost for a 10% PUT. Why so low? Well, a capital lease assumes you’re going to buy the equipment. In fact, the equipment is considered an asset for tax purposes. Capital leases are appropriate for equipment that doesn’t go obsolete quickly and slowly depreciates.
Operating leases are similar to capital leases but with a few key differences. Operating leases are usually for a shorter period, generally two years or less. At the end of the leasing term, you’ll have the option to purchase the equipment (typically for fair market value, which is why you’ll sometimes see these leases called fair market value leases), return it, or renew your lease. Depending on the exact terms of your lease, it may count as an asset or a business expense.
How Heavy Equipment Loans & Leases Work
Heavy equipment loans and leases both work a little differently. As I described above, both feature monthly installment payments and interest. Where loans have down payments, which are paid at the beginning of the loan, leases have residuals, which are paid at the end of the lease. Both residuals and down payments can vary based upon the type of agreement you sign with your financer. In the case of residuals, they may be optional if you choose to return your equipment or renew your lease.
Note that heavy equipment loans and leases aren’t substantially different than other types of equipment financing. The main difference is that you’re dealing with more specialized and expensive equipment than most other industries. That means you’ll need to work with a funder who is willing and able to extend you both the amount of money you need to acquire the equipment and a suitable amount of time to pay it off if you’re buying it.
Used VS New Equipment
Depending on the type of heavy equipment you’re looking for, you may have the option to finance used equipment as well as new. Used equipment can often fall into the hands of equipment lessors (companies offering leases) when the equipment is returned to them rather than purchased. These companies may simply provide operating leases for businesses who will use the equipment for a short time and then return it.
If you’re looking to buy used heavy equipment from a third party, and you need financing, make sure your financer can work with the reseller in question.
Expected Terms & Fees
Generally speaking, the term length of your heavy equipment loan or lease depends on two factors: whether you’re renting or buying, and how long the useful life of the equipment is. It’s rare for a loan or lease to have a term length that’s longer than the equipment’s expected useful lifespan. In practice, you’re probably looking at somewhere around the five-year mark for most heavy equipment financing.
Interest rates on loans and leases can and do vary widely, depending on your financer and your fitness as a borrower/lessee. Interest rates for heavy equipment usually start in the high single digits, with the ceiling somewhere just short of 30%.
Loans and leases can also come with all manner of supplemental fees, or none at all. If you can help it, you should always try to deal with financers who will charge you the least amount of these fees as possible. A standard fee for a loan is the origination fee. This is an amount deducted from the money you receive from your loan rather than a fee you pay directly. Leases, on the other hand, sometimes have administration fees that are charged to “keep your account active.” These may be annual or month-to-month.
Additionally, you can expect to pay late fees if you fall behind on your payments.
What About Collateral?
So that multiton vehicle you’re financing? It’s worth quite a bit, and your financer will either have a lien on it or own the title to it, depending on the type of financing you receive. The nice thing about equipment financing is that the equipment you’re financing is the collateral. If you default on your loan or lease, the financer can simply repossess the equipment.
That said, if you have particularly bad credit, you may also have to make a larger loan down payment or pay a month of your lease in advance.
How The Application Process Works
With any kind of equipment financing, it’s usually a good idea to have the specific make and model of equipment as well as a vendor/seller in mind before you apply to help expedite the process.
If you’re going through a bank, credit union, or captive lessor, you’ll probably need to apply on-site. Online financers, as you might expect, will generally offer the ability to apply through their websites. Both entities will be looking for the following information:
- Time In Business: Has your business been around long enough to be stable?
- Personal Credit Score: How much of your credit are you using, and do you have a history of paying it back on time?
- Debt-To-Revenue Ratios: Are you likely to have the resources to be able to pay your loan and lease?
Your financer will attempt to ascertain all of the above by asking for corroborating documents. You can save yourself some time and grief by having these documents available when you apply:
- Personal identification/driver’s license
- Three to six months of bank statements
- Tax returns/financial statements
- A quote from your equipment vendor
Some financers may ask for additional information.
After you’ve submitted your information, the financer will consider your application and likely do a soft or hard pull on your credit. Equipment financing tends to be on the quicker side as bank financing goes, but with more substantial investments such as heavy equipment, you may be looking at a lead time as long as weeks to a month or two. If you go with an online lender, the process will be much faster — usually measured in days — though you’ll probably end up with a higher rate than you would by going through a bank.
If you’re approved, the financer will usually directly pay the vendor, though, in some less common cases, you may receive the money directly to buy the equipment.
Are You Qualified For Heavy Equipment Financing & Is It Right For Your Business?
Heavy equipment isn’t cheap. Even with generous financing, you’re looking at a significant financial burden. Consider the investment you’re making and to what degree it will directly contribute to your revenue. Does it make more sense to rent or to own?
To qualify for heavy equipment financing, you’ll want to have a credit score of at least 620, preferably higher. Leases, which don’t involve down payments, usually have a higher credit requirement than a comparable loan. That said, don’t assume that you can’t get financing even if your credit is under 620; there may be high-risk lenders willing to work with you…for a price.
Is Heavy Equipment Financing Not Right For You? Your Other Options
Do you still need heavy equipment, but don’t think a heavy equipment loan or lease can get you there? Check our list of top equipment financers to make sure. If you don’t find what you’re looking for there, you still have other options.
Since you’re dealing with expensive items with long utility lifespans, you may want to consider other kinds of long-term loans. In particular, SBA 7(a) and 504 loans can provide the high borrowing amounts and long term lengths you need. Both can be used to purchase equipment.