Equipment finance can help mitigate the uncertainty of investing in a capital asset your business needs until it achieves a desired return, increases efficiency, saves costs or meets other business objectives. Equipment finance may hedge inflation risk because instead of paying the total cost of equipment up front or with a large down payment in todays dollars, the stream of payments delays your outlay of funds. In addition, either a lease or loan can lock in the rates that exist on the date of the closing. In other words, the finance company absorbs the devaluation of your payments over time due to inflation and other financial risks.
Equipment financing provides funding for companies looking to purchase equipment, but lack traditional funding sources to pay for the purchase. Typically with equipment financing loans, the cost of the equipment is spread out over the course of a payment plan which extends over a number of years. For these business funding types, the equipment is used as collateral to help secure the position of the lender and lower the interest rate on the loan.
Equipment finance is often used by growing companies to purchase necessary equipment, but may also be used by established companies to replace tired equipment or upgrade equipment to remain competitive. Some equipment financing companies require a business history of at least 3-years and rates may vary based on how long the company has been in operation. Tangible assets that are peripheral to a company’s operations but are nonetheless necessary. Trucks to transport materials and toilet paper for customer bathrooms are both examples of equipment. Fixed assets that are acquired as additions or supplements to more permanent assets. Equipment includes lighting fixtures in a building, for example. Equipment, unlike real estate, is generally moveable.
Equipment financing is the use of a loan or lease to purchase or borrow hard assets for your business. This type of financing might be used to purchase or borrow any physical asset, such a restaurant oven or company car.
Businesses commonly get equipment financing in these situations:
– you need expensive equipment, but can’t afford to (or don’t want to) purchase that equipment up-front
– you need to replace your equipment frequently because it has a short lifespan or you always need the latest in technology, or
– you need some combination of the above.
Equipment Finance vs. Leasing
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.
An equipment loan is, simply, a loan taken out with the express purpose of purchasing equipment. Normally, the loan is secured by the equipment—if you can no longer afford to pay the loan, the equipment will simply be collected as collateral.
These loans are very good for business owners that need a piece of equipment long-term, but can’t afford to make the purchase outright. A lending institution might agree to extend the majority of the capital so you can pay in periodic increments.
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%.
The other downside is that, in the long term, the arrangement will ultimately cost more than if you had just bought the equipment outright.
Leasing equipment is a popular option if you need to trade out equipment frequently or don’t have the capital to pay the down payment required for a loan.
Instead of borrowing money to purchase the equipment, you’re paying a fee to borrow the equipment. The lessor (the leasing company) technically maintains ownership of the equipment, but lets you use it.
Lease arrangements can vary depending upon your company’s needs. Most commonly, merchants enter into a lease agreement if they need to periodically switch out their equipment for an updated version.
For those who do want to eventually own the equipment, some lessors do offer the option of purchasing the equipment at the end of the term.
Leasing generally carries lower monthly payments than a loan, but might wind up being more expensive in the long run. In part, leases tend to be more expensive because they carry a larger interest rate than a loan.
There are three major types of equipment leasing. Here are the basics of each one:
- Fair Market Value (FMV) Lease: With a FMV lease, you make regular payments to borrow 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. These loans tend to have the lowest monthly payments, but are more difficult to qualify for.
- $1 Buyout Lease: Similar to the above, you make regular payments to borrow the equipment for a set term. At the end of the term, you have the option of purchasing the equipment for $1. Aside from technical differences, this type of lease is very similar to a loan in terms of structure and cost.
- 10% Option Lease: 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 FMV. These tend to carry lower monthly payments than a $1 buyout lease.
A lease tends to be more expensive than a loan, but may offer benefits. 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.
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