Equipment Financing that drives your business forward.
If you own a small business, you know how important it is to quickly and economically obtain, upgrade, or replace the equipment needed to perform your daily tasks. If you decide to purchase equipment upfront, this may negatively affect your cash flow in the future. By financing your equipment, you can keep your business functioning like normal while still having room to expand and grow to meet demand.
Equipment financing refers to a loan used to purchase business-related equipment, such as a restaurant oven, a vehicle, or various office supplies, like computers. Most business equipment financing options include periodic payments with interest and principal over a fixed term. To ensure your loan will be fully paid off in the future, the lender may require a lien on the equipment as collateral against your debt. Once the loan is paid off, you own the equipment free of any lien. 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.
Let’s say you are opening up a restaurant or similar business, and the equipment you need comes to a total cost of $75,000. You decide to 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. This may include the cost of the space, marketing and advertising, and permits and licenses.
There is a difference between business equipment financing and business equipment leasing. This is seen when you pay the owner of the equipment periodic rent for use of the equipment over an agreed-upon period. When your leasing term is up, unless you agree with the owner on an extended lease, the equipment is returned to the owner. The qualifications for leasing are usually less stringent than qualifications for financing. If the equipment is necessary for your business, the endless payments on leased equipment without the prospect of future outright ownership may prove to be a more expensive option.
As with all financing, rates and terms will vary depending on an applicant’s qualifications and current market conditions. Below are some sample rates and terms you can expect when shopping for an equipment loan.
There are two common ways to finance equipment: through a loan or a lease. While both achieve the same ends — giving you access to the equipment needed to run your business — there are plenty of differences between the two methods.
Here’s a rundown on each:
An equipment loan is a loan taken out with the express purpose of purchasing equipment. Typically, the equipment secures the loan — if you can no longer afford to pay the loan, the equipment gets collected as collateral.
Business equipment financing is useful for business owners who require a piece of equipment for a long period of time but can’t afford to make the purchase upfront.
There are a few downsides to this arrangement. Most lending institutions will only agree to pay 80%-90% of the cost, leaving you to cover the other 10%-20%.
Another downside is that your equipment may end up costing you more in the long run than if you had bought the equipment fully. Depending on how much you borrowed, the length of the loan, and the interest rate, your cost of borrowing could change. For this reason, it’s essential to do the math before accepting an equipment loan. Business equipment loan interest rates can vary wildly depending on your lender (8% – 30% is an extremely rough range for what you can expect), your credit rating, the amount of time you’ve been in business, and any number of other arcane formulas a specific lender decides to apply to your case. In most cases, equipment loan interest rates are fixed rather than variable.
If you plan on trading out your equipment often, and upgrading to new equipment, or if you don’t have the capital required to place a down payment on a loan, leasing equipment might be the option for you.
Rather than borrowing money to purchase the equipment for yourself, you are instead paying a borrower’s fee. The lessor (the leasing company) technically maintains ownership of the equipment but lets you use it for a fee.
Lease arrangements can vary depending upon your company’s needs. Most commonly, merchants enter a lease agreement if they periodically need to switch out their equipment for an updated version.
If at the end of the term you find that you want to purchase your equipment, certain lessors might allow for this to happen.
By taking out a lease for your business equipment financing, you may experience lower monthly payments than a loan, but you may also wind up paying more in the long run. In part, leases tend to be more expensive because they carry a larger interest rate than a loan.
There are two major types of leases: capital and operating. The former functions a bit like a loan alternative and is used to finance the equipment you want to own long term. The latter is closer to a rental agreement and, in most cases, you’ll return the equipment to the lessor at the end of the lease. Both types have numerous variations. Here are a few common types you’ll come across:
With an FMV lease, you make regular payments while borrowing the equipment for a set term. When the term is up, you have the option of returning the equipment or purchasing it at its fair market value.
A type of capital lease where you’ll pay off the cost of the equipment, plus interest, over the course of the lease. In the end, you’ll owe exactly $1. Once you pay this residual, which is little more than a formality, you’ll fully own the equipment. Aside from technical differences, this type of lease is very similar to a loan in terms of structure and cost.
This lease is the same as a $1 lease, but at the end of the term, you have the option of purchasing the equipment for 10% of its costs. These tend to carry lower monthly payments than a $1 buyout lease.
By obtaining business equipment financing, this may be more expensive, though their fixed interest rates tend to fall within a similar range as equipment loans. You might even have the option to write off the entirety of the cost of the lease on your taxes.
A lease tends to be more expensive in practice, though their (usually fixed) interest rates fall within a similar range to equipment loans. Depending on the arrangement, you might be able to write off the entirety of the cost of the lease on your taxes, and leases do not show up on your records the same way as loans. How leases affect your taxes is too complicated to cover within the scope of this article, but the type of lease you select will determine what you can write off and how.
Is a loan or lease better for your situation? Here are some questions you can ask yourself to find out.
If you can’t afford to pay 20% of the value of the equipment, you might have difficulty finding a lender that is willing to work with you. In this case, a lease might be your only option.
Since business equipment leases tend to carry smaller monthly payments than a loan, this option may be worth checking out, especially if you’re operating on a thin profit margin. Be aware that if you are planning on purchasing the equipment at the end of the term, you’ll likely have to pay all or some of the cost of the equipment, costing you more in the long run.
Often it is safe to assume that if you need a certain piece of equipment for more than three years, purchasing—through your funds or a loan—is the better option. While both loans and leases offer the opportunity of owning the equipment at some point, loans tend to be less expensive.
Leasing may be the cheaper option if you decide to use equipment that will go obsolete earlier or wear out easily. At the end of the lease, you don’t have to decide what to do with the outdated equipment.
On the other hand, when shopping for a lease, you want to be sure that your equipment isn’t going to become obsolete before the lease terms are up. You’re still responsible for paying until the end of the term, even if you can no longer use the equipment.
For more information on our business equipment financing options available from BitX Funding, contact us today!
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