5 FAQs About Equipment Financing
with Middletown District Leader Josh Galloway
1. What is equipment financing?
Equipment financing is when a business uses a loan or lease to obtain equipment needed for the business. The equipment itself is considered the collateral, meaning that the bank can reclaim it if payments fall behind, which gives the bank more confidence in the loan.
Due to the collateral, an equipment loan is considered a secured loan. This can result in a smaller down payment than other loans, and maybe even a lower interest rate, although details vary based on the credit rating of the business, terms of the loan, and even the projected value of the equipment. It’s generally a good solution for a piece of equipment that will be considered an asset once the loan is paid and the business owns it. In fact, once owned, the equipment can even be used as collateral for other future loans.
A lease is appropriate for short term financing or situations when the business cannot make a large down payment. The business can pay monthly to have the equipment and either lease until they own it or return it at the end of the lease period. For industries where technology quickly become obsolete, leasing is a great option—it can provide access to updated technology without committing to a long-term loan that may outlast the relevance of the equipment itself.
2. What is equipment financing most often used for?
There are several reasons to use equipment financing, but I can say I see a few key trends. It is frequently used to increase capacity. When a business is receiving more orders than can be fulfilled, equipment financing can add to or upgrade the tools and increase capacity. It is also an option often used when a business is ready to add a new service that they do not currently provide, expand into a new market, or even purchase another business or practice. And, of course, it’s a common resource when current equipment breaks beyond repair or requires updating to stay competitive.
3. What size does a business need to be for equipment loans to make sense?
I don’t think there is a minimum or maximum business size for equipment financing to make sense. On the smaller end, a single owner electrician doing $150k in revenue per year still needs a vehicle and tools to perform their work. Without it, the company can’t operate or generate revenue. On the larger end, a multimillion-dollar machine shop probably has several different machines to cut, shape, and mold raw goods into products for a wholesaler or end user. Those machines will inevitably need to be replaced or new machines added to expand the company. While individual machines may not make or break operations, a down machine or inability to expand means that the company is either losing revenue or capped out at how much it can produce. To me, this is just as vital the single owner electrician’s vehicle, just on a larger scale. Equipment financing can be a valuable solution for businesses of any size.
4. When should a business consider different lending options?
If a company is purchasing a fixed asset such as a vehicle or piece of machinery, equipment financing is the preferred route. Securing equipment as collateral allows a lower rate, longer term, and typically 90%-100% LTV. Other types of loans would be better for situations like the purchase of commercial real estate, or more repetitive needs such as for general operating funds or working capital. If purchasing commercial real estate, we would look to secure the property being purchased. If general working capital is needed, a revolving line of credit is the better option.
In my career I have frequently encountered business owners wanting a line of credit to purchase a vehicle or equipment. In that situation, it is the financial partner’s responsibility to advise their client that a fixed rate, fully amortized term loan is the better option. This not only gives the borrower a lower, fixed interest rate, but it also amortizes over the life of the loan into principal and interest payments. This helps the borrower work towards paying down or paying off the loan, and it avoids a “stale” line of credit.
5. What industries rely on equipment finance loans?
Honestly, any industry can benefit from equipment financing—it’s more about growth milestones for a given business. That being said, in my experience, I’ve seen equipment financing being used more often within manufacturing and machine shops, including computer numerical control (CNC) like drills, lathes, mills, grinders, routers and 3D printers. It is also pretty common in various service industries like landscaping, electrical contractors, land clearing and construction, etc. But again, equipment financing is a valuable option to consider for moments of expansion or upgrade, no matter the industry.
