Equipment Financing – How it Works?
Equipment financing is a form of secured loan when you buy new equipment for your business. You can also secure loans against used equipment under business ownership. In both scenarios, the underlying equipment or machinery works as collateral for the lenders. As backed by collateral, these loans are termed secured loans and often come with lower interest rates.
How it Works?
You can pledge any tangible assets such as machinery, equipment, or valuable tools as collateral to secure these loans. For used equipment, the lenders may allow up to 50% of the loan amount against the residual value of the asset. Many businesses apply for equipment financing when purchasing large machinery. For new equipment and machinery, the lenders may allow up to 100% loan amount of the asset value.
Equipment loans work as an alternative financing option for businesses looking for some quick cash. Businesses with large tangible assets such as retail, construction, and hospitality can use the equipment financing option easily.
The Buy Vs Lease Decision:
As a business owner, you may choose to buy an asset with cash or lease it.
Buying an asset requires a large up from cash. Your business owns the assets right away, which you can use as collateral to secure loans or sell off the asset. Buying equipment with cash increases your business assets and creditworthiness. It is suitable for businesses with surplus cash looking to purchase small value assets such as office equipment.
Leasing an asset requires low down payments. You can use the machinery or equipment without full ownership. It works as a loan repayment with interest and repayment tenure. It’s a suitable option for businesses looking to buy large equipment and heavy machinery such as construction machinery etc. these assets come with large residual value and leasing can bring business benefits.
Sale and lease-back is another popular equipment financing option for many businesses. You can sell the machinery to a vendor and lease it back to continue using it. However, you’ll have to forgo the asset ownership.
Pros and Cons of Equipment Financing:
Businesses with large tangible assets find equipment financing option suitable. As a secured loan type, it offers quick access to financing with flexible terms.
Pros:
- Comes with low-interest rates as loan is backed by collateral
- Fast loan approvals
- Flexible repayment terms
- Businesses can continue using equipment and secure cash without selling the assets
Cons:
- Businesses need a strong credit profile and high business credit scores
- Collateral is mandatory and default may result in seizure of assets
- Increases pressure on business working capital management
- Used equipment can secure limited loan amounts
- Obsolete assets may not come with the loan approval surety
- Business owners may require to pledge a personal guarantee
Equipment Financing is best for you if:
- You are looking to invest in large value machinery or equipment
- Lack upfront cash required to buy new assets
- You lack access to business loans with a low credit score
- You are looking to utilize the sale and lease-back option for large assets
- If your business does not have a long credit history and lack access to other financing options
