What is Equipment Finance?
Equipment finance describes a loan or lease that is used to obtain business equipment. Business equipment may be any tangible asset other than real estate – examples include office furniture, computer equipment, machines used in manufacturing, medical equipment, and company vehicles.
- Equipment finance describes a loan or lease that is used to obtain business equipment, which can be any tangible asset other than real estate.
- Equipment financing may be through obtaining a loan to purchase equipment or by leasing equipment.
- Whether buying or leasing is a better option usually depends on the nature of the equipment being financed and the borrower’s ability to obtain a loan at favorable terms.
Understanding Equipment Finance
Equipment finance is an important part of business operations for a couple of reasons. First, for a startup or early-stage company, equipment financing may be an essential step in getting the business going.
Second, because equipment financing is typically used to obtain costly equipment, the debt obligation incurred represents a significant financial commitment. Therefore, business owners or company executives must carefully consider any equipment finance plan and try to secure the best possible financing terms.
There are two primary options for equipment financing: obtaining a loan to purchase equipment or leasing equipment. Whatever option may be best for your business depends on several factors, such as your business’ credit rating (which impacts the interest rate at which it can borrow money) and the useful life expectancy of the equipment being financed.
Purchasing Equipment with a Loan
When you obtain business equipment using a loan to purchase it, the equipment serves as collateral for the loan. Thus, the lender holds a lien on the equipment and can take possession of it should the borrower default on making the loan payments.
Because there is substantial collateral for the loan, a bank or other lender may be willing to lend up to 100% of the equipment’s value; however, loans up to 80% of the equipment’s value are more common. Therefore, even with an equipment finance loan, the borrower may need to provide a sizable down payment.
A business owner should carefully examine their ability to make loan payments. If they doubt their ability to keep up with the payments, leasing equipment may be a better option.
Loan terms for business equipment range anywhere from several months to 10 years or longer. Interest rates for equipment financing vary widely – they can range from 4%-5% up to 30%. The determining factors are primarily the credit rating of the business or business owner, how long the business has been in operation, the length of the loan term, and how well the purchased equipment is projected to hold its value.
One key benefit of purchasing equipment, as opposed to leasing it, is that when the equipment loan is paid off, the business owns a valuable asset. If the business needs to borrow cash for another purpose, such as expanding business operations, the previously purchased equipment can be used as loan collateral to obtain more favorable loan terms.
Leasing, rather than buying, equipment may be an attractive option for any number of reasons. First, obtaining a loan to purchase equipment may not be viable if the borrower can’t cover the necessary down payment or qualify for the loan. Second, leasing is often a less expensive option, especially for short-term financing, as it usually requires no down payment and does not include having to pay a large amount of interest.
Another reason companies or business owners may consider leasing is related to the nature of the equipment being acquired. If you’re looking to finance equipment that quickly becomes obsolete and needs to be replaced, such as computer equipment or vehicles, then leasing may be a much more favorable option. In such a way, you have the option of leasing new, more updated equipment as time passes. However, if that is your plan, you should carefully consider the lease terms, such as whether there is any financial penalty for terminating the lease early.
Some leasing contracts provide a purchase option at the end of the lease term. The most obvious consideration for a business owner here is whether they expect to purchase the leased equipment eventually.
The primary advantage of using a loan for equipment finance is owning the asset at the end of the loan term. The primary advantage of leasing is not having to worry about the equipment becoming outdated and losing value.
To learn more about the different options for funding equipment purchases, check out CFI’s Equipment Finance Course Overview!
CFI is the official provider of the global Commercial Banking & Credit Analyst (CBCA)™ Program, designed to teach you all the knowledge and skills required to become a skilled credit analyst. The following CFI resources will be helpful in furthering your financial education and advancing your career: