At some point, every business needs to acquire, upgrade, or improve on its equipment and machinery. This is necessary because new equipment gives your company access to newer technologies, which are typically more efficient. It also makes the business more flexible and responsive to industry changes.
In other words, upgrading equipment may be the difference between the survival and failure of your business. Unfortunately, equipment and machinery are often costly. And that’s where equipment loans come into play.
These short to medium-term business financing options offer a lifeline, particularly if you own a small business that doesn’t have a vast cash flow. But before you make the big leap, you’ll want to thoroughly understand what equipment financing is, how it works, and whether your business is eligible.
What is equipment financing?
Equipment financing is a type of business loan that’s specifically meant for purchasing or upgrading machinery and equipment that is essential to the running of your business. Equipment can include restaurant ovens, computer systems, industrial equipment, vehicles for consumer use, copiers, furniture, farm machinery etc.
They are basically things that your business needs to produce its core products or offer core services. Oftentimes such tools are too expensive to finance one-off with company profits. But with equipment loans, you can purchase the tools you need and pay off the loan with monthly payments over several years.
How do equipment loans work?
In their most basic form, equipment loans are credit facilities that provide your business with cash for the types of equipment and machinery that you need. You then have to repay the loan in full, typically in monthly payments.
The loan amount for equipment financing varies depending on the equipment you’re trying to buy and also from lender to lender. Generally, equipment loan amounts can be as little as $5,000 or as high as $500,000. With 504 loans, you can get up to $5 million for high-cost purchases. You’ll want to ensure that the size of the loan you apply for matches the price of the equipment you are purchasing.
One thing with equipment financing is that the equipment itself serves as collateral for the loan. Should you fail to repay the loan, the lender can seize the equipment. This is known as a self-secured loan; i.e., the equipment acts as its own security for the loan.
Interest rates for equipment loans typically start at around 5% all through 10% APR. SBA 504 loans have the most competitive rates of around 2.25%. However, SBA loans are also the hardest to qualify for. They attract very high competition because of their low rates and favorable terms.
For example, the typical loan duration of SBA loans is 10 years, but you can get up to 25 years to repay. Most other equipment loans, including those from banks, online lenders and credit unions have terms of between six months to seven years.
Ideally, you want a loan term that’s as long as the expected duration of the equipment you’re buying. Otherwise, if the term is too short, you may find yourself scrambling to make your monthly payments. On the other hand, a longer duration than necessary will see you paying for the equipment even after your business has stopped using it. Besides, a longer loan term means that you’ll have more interest to pay.
Does my business qualify for an equipment loan?
Depending on the industry, your business may need a new stove so that you can add a particular meal on the menu. Perhaps a forklift that can handle heavier loads or modern computers to streamline production activities. Whatever the case, business equipment loans can help you complete the purchase.
But does your business qualify for these loans? While each lender has their own set of requirements, there are general guidelines that you can expect to meet. For example, oftentimes lenders will require excellent credit before approving you for equipment financing.
A credit score of at least 600 is common. However, you can qualify even with a lower score because equipment loans are by nature self-secured. That means the equipment itself acts as collateral, which incentivizes lenders to relax their credit score requirements.
Despite their self-secured nature, equipment loans still require you to make a down payment. The exact value varies from lender to lender, but expect anywhere between 5% and 20% down. If you’re going for SBA equipment loans – popularly known as SBA CDC/504 – then the hard rule is 10% down. Your business must also operate for profit and have some equity. In other words, it should be a profitable company.
Most lenders also require that you must have been in business for at least six months. This is especially the case if you’re looking to get equipment loans for small businesses. The longer you’ve been in business, the lower your risk level as a borrower.
Some lenders, including Crest Capital, do not have minimum annual revenue requirements for their business equipment loans. This can be a huge advantage if your business is not very profitable or doesn’t register big sales figures. However, a majority of financial institutions will want to see that you make at least $100,000 in annual revenue before they approve your equipment financing application. BlueVine, for example, requires $120,000 while National Funding requires $150,000 annual revenue.
Where to get business equipment loans
As a small business owner, you can get equipment loans from traditional banks, online lenders, community banks, and credit unions. The SBA doesn’t generate any equipment loans. Instead, it guarantees them, allowing private lenders to originate the loans with minimal risk. Thus, if you want to apply for SBA equipment financing, you’ll have to do it through a private lender.
Traditional banks typically offer the lowest interest rates for equipment loans for small businesses. However, they have strict qualification standards which often lock out most small businesses. For example, you’re unlikely to qualify for equipment financing from a bank if you have a credit score of under 650.
Although they excel at offering personalized financial services, community banks typically offer smaller loan amounts. This makes them less ideal if you want high-value equipment loans. In fact, if you’re looking at amounts in excess of $1 million, you’re better off checking with commercial banks. Better yet, try the SBA CDC/504, which is one of the best credit facilities for purchasing costly assets.
But as already mentioned, SBA and bank loans are not the easiest to qualify for. That’s where online small business lenders come in clutch. Their fast-processing times make them great if you’re looking to purchase equipment quickly. Besides, most online lenders have relaxed borrowing terms. For example, they may approve your application even if you have poor credit. For this reason, online lenders are ideal if your business and personal finances and credit scores are not in excellent shape yet.
Ultimately, the best place to go for equipment financing is your current bank. They understand your finances and are likely to tailor the loan based on your cash flow.
How to get equipment loans: a step-by-step guide
Step 1: Ensure your credit score is good
If your credit score isn’t already good, consider working on building it first before applying for an equipment financing loan. This applies to both personal and business credit scores. It takes at least six months to repair bad credit.
A good credit score will not only increase your chances of qualifying for business equipment loans, but it will also earn you favorable lending terms. You can get a low interest rate, longer repayment period and ultimately lower monthly payments.
Step 2: Create an effective business plan
Lenders want to know that your business actually needs the money you’re borrowing and that it’s capable of paying it back in full. While they’ll do their due diligence by examining your financial statements, you can point them to your future plans of success using a business plan.
In the business plan, introduce your company then proceed to outline its industry, management structure, current cash flow, primary market, target audience, plans of growth, and your roadmap to success. Make it as ambitious as possible but truthful and realistic. The lender will use this to analyze your growth projection and ability to handle credit.
Step 3: Prepare the required documentation
Alongside an effective business plan, you also want to have all your updated financial documents in place. Equipment financing requirements vary from one lender to another, but oftentimes you’ll have to avail:
A quote (or invoice) for the equipment you’re trying to purchase
Up to three months of bank statements
Your personal and business tax returns
Updated financial statements, including a cash flow statement, income statement and balance sheet. Make sure they clearly indicate your annual revenue because that’s an important consideration to the lender when they are processing your application for equipment financing
Business licenses and documentation that shows that your company is legitimate
It’s not uncommon for equipment financing lenders to also ask for personal documentation such as your Social Security Number and bank statements. All these documents prove that you are legitimate and capable of meeting monthly payments for the loan.
Step 4: Complete application
Do you have a bank with whom you already do business? Consider applying for equipment loans with them. Otherwise, feel free to shop around for a lender that offers terms that are good for your business. Your options range from traditional and community banks to credit unions and neo banks.
Most financial institutions that offer equipment loans for small business will give you the option to apply online. But if you prefer a personalized experience, you can walk to any branch of the bank of your choice and make an application. Of course, that is not an option if you’re borrowing from a neo bank or online lender because they offer all their services online.
Once you have identified your preferred lender, go ahead and fill the application form. Submit, alongside with all the documents that they require, and wait for the lender’s response. Neo banks and online lenders have the fastest processing times for equipment loans. You can know the verdict in as short as 30 minutes and get the funding in seven days or less. On the other hand, SBA loans take the longest – about 60 to 90 days.
Equipment financing vs. equipment leasing
If you need business equipment but are not entirely sold on taking out a loan for purchasing it, you can consider leasing that equipment instead. The biggest difference between equipment leasing and financing is ownership. When you finance something, you get full ownership and can decide what to do with it. The lender can only seize it if you fail to make your monthly payments.
On the other hand, equipment leasing gives you temporary ownership. The equipment essentially belongs to someone else but they let you use it over a given period of time for a fee. Equipment leasing typically comes with restrictions on what you can do with it. For example, a forklift owner may limit how much weight you can hoist with their machine when you lease it.
The restrictions on leased equipment can be disadvantageous. However, the tradeoff is that leasing is cheaper and doesn’t always require a down payment. If the equipment owner asks for a down payment, it will be smaller than what you stand to pay should you take the financing route. This can be very advantageous if you own a small business that doesn’t have lots of cash to work with.
The down payment when financing business equipment is almost always 20%. This means you’ll be left with around 80% to finance. The good news is that you own the equipment from day one.
With leasing, you typically have to finance up to 100% plus 20 to 25% of all additional costs (known as soft costs). These costs include things like taxes and delivery fees. At the end of the lease, you can choose to return the equipment or purchase it at its appraised market value. That’s the other advantage of equipment leasing – it gives you options at the end of the lease.
Alternative ways to finance business equipment
As a small business, equipment financing is one of the easiest ways to acquire costly tools that your business needs. But it’s not the only way; there’s also leasing. Beyond those two, you can also use online loans, traditional bank loans, SBA loans, business lines of credit, and business credit cards. Here’s a breakdown of your credit and loan options.
Loans from online lenders and neobanks
Online lenders and neobanks provide small business loans that are easier to qualify for than traditional business loans. Most of them don’t do hard credit checks and quite a good number won’t even consider your personal credit. This makes them ideal for business owners who haven’t had enough time to build their credit.
On the downside, most neobanks and online lenders don’t offer loan amounts as large as commercial banks. Oftentimes, the amount will max out at $250,000. So, if you’re trying to buy extremely costly equipment, these loans may not be able to cover the full amount.
Bank term loans
Applying for business equipment loans seems like the obvious route when you’re looking to buy business equipment. However, in case you fail to qualify for equipment financing, you can consider applying for a traditional bank term loan. It may be a particularly good option if you want a credit facility that you can pay back over an extended period – up to 10 years.
Besides, bank term loans carry large amounts of up to millions of dollars. This makes them ideal for buying costly business equipment. However, they are not the easiest to qualify for. In addition to a stellar credit score of 680 and above, most banks will also require annual revenue of at least $100,000 and a debt-to-income ratio of 43% or lower.
The SBA 504 loans are specifically meant for purchasing small business equipment and real estate. But it’s hard to qualify for. The good news is that it’s not the only SBA loan that you can apply for. Your other options include SBA 7(a), which is meant for working capital. This loan offers up to $5 million.
In case the equipment you’re looking to buy is not very costly, then you can consider applying for the SBA microloan. With an amount that maxes out at $50,000, it’s not the biggest loan out there. But it can still finance some equipment like vehicles, commercial ovens and a variety of farm tools.
Finally, if your business was affected by the coronavirus pandemic, you can try your luck with the SBA disaster loan. Created for small businesses that have been impacted by natural disasters, this loan maxes out at $2 million. The SBA allows business owners to use SBA disaster loan proceeds to repair or replace machinery, equipment, real estate etc.
Small business lines of credit
A business line of credit is a revolving loan that your business taps into whenever it’s strapped for cash. Say, for example, that a lender gives you a $100,000 line of credit. You can withdraw from that fund any time you need cash, provided you don’t exceed the maximum limit of $100,000.
You have to pay back the amount you withdraw, albeit not all at once. You can pay back slowly depending on your agreement with the lender. Any amount you repay goes into your fund and you can use it again. This is what makes a business line of credit a revolving fund.
Depending on the limit set by the lender, you can use a business line of credit to purchase business equipment. If you have a good credit score and decent annual revenue, a lender can give your business a line of credit of up to $500,000 or even more. Depending on the equipment that your business needs, such an amount may be more than enough to finance the purchase.
Small business credit cards
Business credit cards work in the same way as consumer credit cards. A card company gives your business a credit card that you can use for purchases. Every time you use the card, you’re borrowing money. The lender will set a maximum amount that you can use.
High-limit business credit cards max out at $50,000 or more. Depending on the equipment you want to buy, that may be enough. Keep in mind that the lender will set a minimum amount to repay each month. Every time you make a payment to your credit card, the amount goes into your fund and you can borrow it again. This makes a credit card a revolving fund as well.
Click here to learn the difference between a business line of credit and a business credit card.
The bottom line
Equipment loans offer a great way to purchase or upgrade costly business equipment. Since they are self-secured, these loans are fairly easier to qualify for compared to traditional loans. They are particularly straightforward if you apply from online lenders because they have more relaxed lending terms and streamlined approval processes.
However, if you do not want to take up a big debt, consider equipment leasing. It gives you the chance to use someone else’s equipment, albeit with a few terms and conditions. Nonetheless, equipment leasing is a great alternative to equipment financing if you don’t have the budget to make monthly loan payments.
Looking to grow your business? Check out these additional small business guides that can help you take your business from 0 to 100.