Table of Contents
What are Equipment Loans
Equipment loans are loans that are collateralized by equipment, machinery, vehicles, or other types of equipment used by a business. This includes software used by a business that is deemed essential for operations. That last part is important, “used by a business.” Equipment loans come with different terms and structures. Your typical equipment loans are anywhere from 12 – 84 months long and have interest rates (as of today, Jan 04/ 2024) ranging from 5% to 9%. Equipment loans are extremely flexible. Not many know all the true ins and outs of them. You can do things like add a balloon/option payment at the end of the loan to lower the monthly payment. You can have the payment go to 0 in your slow seasons; we see this often when farmers get equipment loans for agricultural equipment. I will share all the secret ins and outs of equipment loans below.
Are equipment loans easy to get?
Yes, equipment loans are surprisingly easy to get. You only need a few things to get approved for an equipment loan
- 6 months in business
- 3 months’ banking statements showing revenue/ deposits
- Financing application
- Invoice for the equipment you want/ need to purchase.
Getting the Best Terms with Equipment Financing
Equipment loans are often not black and white. There is a lot of grey area and room to make your case. When it comes to equipment loans, lenders look at the three Cs.
Character: Lenders will pull your personal FICO score and, often, your Paynet report as well. These are your credit reports, which make up your character. They are your history of paying back the people you borrow money from. Lenders consider this your character and look at it heavily.
Collateral: This is the machinery, equipment, heavy equipment, or software (yes, you can finance software) you are going to be purchasing
Cash flow: Do your business deposits come into your business account each month? Lenders want to see that you have deposits or cash flow each month you have been in business.
You typically want to have a strong 2 out of the 3 c’s; most of the time, you can get approved. The stronger your character is, also known as credit, the better terms you will be offered. The same goes for Collateral and cash flow. The better the resell value of the equipment is, the better terms you will get. The better cash flow your company shows, the better terms will be, such as 0% down, lower interest rate, longer terms, etc.
Unique Structures
As I stated earlier, “Equipment loans are not black and white.” That is because they are amongst the most flexible of loans. This unique feature is primarily due to these loans being secured or collateralized by a physical asset, i.e., equipment, machinery, etc. Below are a few unique features you can request when getting an equipment loan.
Balloon payment: This is when the lender defers a % of the principal until the end of the loan term. This allows for a lower monthly payment to the borrower, but the borrower either has to refinance at the end of the loan term or pay the entire balloon payment amount.
Here is an example: The loan amount is $500,000 amortized over 72 months at 6%. The lender agrees to a balloon payment option of $200,000. So, instead of the payment being $8,286.44, the payment on the $500,000 loan with a $200,000 balloon option gets reduced to $4,971.87. This reduction occurs because the borrower no longer pays a $500,000 loan. They are paying down a $300,000 loan ($500,000 minus the balloon amount of $200,000 = $300,000), which almost cuts the payments in half. However, after 72 months, the borrower must come up with $200,000 or refinance.
Equipment leasing: Instead of buying the equipment outright, the lender holds the title, and the borrower rents it from the lender. This is commonly referred to as a leaseback. It is an effective way to achieve a lower monthly payment. Equipment leasing is straightforward; the best way to explain this is through an example.
Let’s say a tractor is being purchased for $200,000. The payment on a $200,000 equipment loan, with a 36-month term at a 7% interest rate, would be $6,175.42 monthly.
With a lease, however, the borrower agrees to a residual value, which is the asset’s value after the lease term is over. This value is expressed as a percentage of the original value. Let’s assume the residual value is 50%, meaning the equipment is worth $100,000 after the lease term. Then the borrower would have a lease payment of $3,087.71. This reduction occurs because the borrower only pays for $100,000 worth of the equipment’s value rather than the full $200,000.
Equipment loan down payment reimbursement: You see this frequently in the restaurant industry. Someone orders equipment and is forced to put a down payment on it. Here’s a strategy you can use: When getting approved for an equipment loan, request that your loan officer gets you approved for the entire invoice amount, not just the remaining balance. Once the equipment loan funds, you can have the vendor wire you back the difference or have the lender wire you back your initial down payment. This demonstrates another way equipment loans can be very flexible.
Seasonal payments: If you have a highly seasonal business, such as farming, movie theaters, ice cream shops, snow removal services, or lawn care and gardening, you can request that the lender structure the loan so that payments are higher during your busy months and lower or nonexistent during the slow months. This is common in the agricultural industry. Farms, for example, typically only make equipment payments during harvest season and not during the other months.
Cash-out Equipment Loans: This is when a lender gives you a loan for equipment you purchased earlier. This is referred to as a cashing out or an equipment cash-out loan. Here is an example:
Joe’s Excavation Company has two D10 Dozers worth about $500,000. Joe’s Excavation Co. also has $200,000 in high-interest loans. Joe asks his lender, Niche Capital Co, for an equipment cash-out loan. We lend him 50% of the value of his two D10 Dozers, which is $250,000, referred to as the loan-to-value ratio. Joe uses the money to pay off his high-interest loans and puts $50,000 in the bank for a rainy day. Joe used his equipment as collateral to pull cash out of them and secure a stable, low-interest cash-out equipment loan.
To do this, you will need the following.
- The Original invoice for the equipment
- Proof of the equipment being paid for
- Credit application
- 3 months banking statements
How hard is it to get a loan for a piece of equipment?
It is easy to get a loan on a piece of equipment, assuming it has good resell value and you have a business with cash flow and credit.
You simply need an invoice for the equipment you want to purchase, a credit application from the lender, and three months’ bank statements from your business bank account.
Even if you have already purchased the equipment, you can still get a loan on it to reimburse yourself. Let me give you an example. If you purchased a piece of equipment with no loan of $50,000 30 days ago, You can go to your lender with your original invoice, proof of payment, and other financials and ask them for an equipment loan. Instead of the lender wiring the money to the vendor. The lender will wire the money to you and reimburse you for the purchase. The shorter the time between purchasing the equipment and asking the lender for an equipment loan, the better your terms and rates will be.
What credit score is needed for an equipment loan
You need to have a 600 or higher FICO score to qualify for an equipment loan. However, if you are under a 600 FICO score, you can still qualify if you buy equipment that holds value and have good business cash flow. Equipment lenders can work with what you have. You can get approved if you have good credit but poor cash flow, and the equipment you wish to purchase holds value. You can get approved if you have poor credit, good cash flow, and strong collateral.
Simply put you need to have a strong two of the following:
- Good Credit
- Good Cash flow
- Collateral that holds value
Can you write off an Equipment Loan?
Yes, you can write off equipment loan expenses. The following are what you can write off.
Loan points and fees: Any loan fees you paid when the loan closed.
Interest Deductions: interest paid on equipment loans is generally tax-deductible as a business expense. This means that the portion of each loan payment that goes towards interest can reduce the business’s taxable income.
Section 179 Deduction: You may qualify for the Section 179 deduction, which allows them to deduct the full purchase price of qualifying equipment in the year it was purchased and put into use, up to a certain limit. This can apply whether the equipment was purchased outright or financed.
Depreciation: The cost of equipment is usually not immediately fully deductible. Instead, businesses typically write off the cost of the equipment over its useful life through depreciation, spreading the expense deduction over several years.
Bonus Depreciation: In addition to Section 179, bonus depreciation can allow businesses to deduct a substantial portion of the purchase price of new equipment in the first year it’s used.
Summary
At Niche Capital, we love equipment loans because they are tangible and flexible. Equipment loans allow businesses to acquire necessary machinery without the upfront cost, offering perks like better interest rates when using equipment as collateral. Whether it’s for farming, construction, or any other industry, equipment loans provide a reliable way to finance growth and maintain cash flow. We’ve outlined various options, including leasing, cash-out loans, and seasonal payment structures to accommodate different business needs. If you have any questions, fill out our 2-minute questionnaire, tell us how we can help, and book a time to speak with us. Looking forward to speaking!
