What Is Equipment Financing & How Does It Work?

Whether you’re running a restaurant, a construction company, or even working out of your home, chances are your business needs equipment to perform its basic functions. If you can’t pay for equipment out of pocket, your best option may be to seek equipment financing.

If you need to break down the costs of expensive equipment into easy-to-manage payments, keep reading to learn more about equipment financing, how it works, and associated costs. Then make sure to check out our picks for best equipment financing companies once you’re ready to make your purchase.

What Is Equipment Financing?

Equipment financing is the use of a loan or lease to purchase or borrow hard assets for your business, such as a company car or restaurant oven. There are multiple variations of equipment financing for specific types of businesses and equipment.

With equipment financing, the asset you’re purchasing serves as collateral. If you default on your loan or lease, the lender can repossess the asset. Because of this, equipment financing tends to be a more cost-effective and lower-risk way to acquire equipment than other forms of financing.

When To Use Equipment Financing

Any business that utilizes physical equipment such as vehicles, computers, and machinery can make use of equipment financing.

Business owners commonly get equipment financing in these situations:

• You need expensive equipment but can’t afford to (or don’t want to) purchase that equipment upfront
• You need to replace your equipment frequently because it has a short lifespan, or you always need the latest in technology

If your business is in a similar situation, equipment financing may be the right choice for your business.

How Does Equipment Financing Work?

When you’re seeking equipment financing, you’ll generally want an idea of what you’re buying before you even contact your equipment financer. You’ll also want an idea of who you’re planning to buy it from.

In most cases, your equipment financer is covering either all or a percentage of the cost of your equipment. Many equipment financers directly pay the vendor for the equipment without the money ever entering your bank account.

The exact terms of your financing will differ depending on whether you’re getting a loan or lease (more on this below), but most equipment financing terms last somewhere between two and seven years. Over that time, you’ll typically make monthly payments to your equipment financer to pay off the principal plus interest. Should you default on your loan or lease, your equipment financer will typically repossess your equipment to resell it.

How Much Does Equipment Financing Cost?

The cost of borrowing with equipment financing varies based on factors including:

• The amount borrowed
• The interest rate
• Term length

Borrowing limits, interest rates, and repayment terms are generally determined by your credit rating, time in business, annual revenues, and other factors.

Types Of Equipment Financing

There are two common ways to finance equipment: equipment loans and equipment leases. Here’s a rundown on each:

Equipment Loans

An equipment loan is a loan taken out with the express purpose of purchasing equipment. A lender extends the capital upfront to purchase the equipment, and the borrower pays the loan off through smaller installments over time.

There are a few downsides to equipment loans. Some lenders only pay 80% to 90% of the cost, leaving you to cover the remaining 10% to 20. Equipment loans are also more expensive than purchasing equipment outright

Here’s an example of what an equipment loan might look like for a $25K piece of equipment:

In the example above, using a loan will cost almost $2.5K more than purchasing the equipment upfront. On the other hand, the monthly payments are much more manageable than a large one-time payment.

Equipment loan interest rates vary by lender and other factors. A rough range of interest rates is 8% to 30% for equipment loans. In most cases, equipment loan interest rates are fixed rather than variable.

Equipment Leases

With equipment leasing, you don’t borrow money to purchase the equipment. Instead, you pay a fee to borrow the equipment from the lessor (the leasing company), who maintains ownership of the equipment.

If you want to own the equipment, some lessors offer the option of purchasing the equipment at the end of the term.

Equipment leasing 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. It’s also more likely to cover additional soft costs associated with shipping and installing the equipment.

There are two major types of leases:

• Finance Lease: A finance lease is similar to a loan and is used to finance equipment over a longer term. Typically, the lessee takes ownership of the equipment at the end of the lease. This type of lease is also known as a sales lease or capital lease.
• Operating Lease: An operating lease is closer to a rental agreement and, in most cases, you’ll return the equipment to the lessor at the end of the lease.

While there are two main types of leases, there are several variations. Here is an overview of the most common types.

• Fair Market Value (FMV) Lease: When the lease term is up, you have the option of returning the equipment or purchasing it at its fair market value.
• $1 Buyout Lease: At the end of this capital lease, you’ll owe exactly $1. Once you pay this residual, which is little more than a formality, you’ll fully own the equipment.
• 10% Option Lease: At the end of your lease, you have the option of purchasing the equipment for 10% of its costs. These tend to carry lower monthly payments than a $1 buyout lease.

Here’s an example of what a 10% option lease might look like for $25K worth of equipment:

A lease tends to be more expensive in practice, though their (usually fixed) interest rates fall within a similar range to equipment loans.

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.

Is An Equipment Loan Or Lease Right For Your Business?

Is a loan or lease better for your particular situation? Here are some questions you can ask yourself to find out.

Borrowing Requirements For Equipment Financing

Equipment loans and leases tend to be a relatively conservative type of financial product. In most cases, you’ll need to have good credit (600+), and you should be able to demonstrate the ability to make your loan or lease payment.

Lenders may consider revenue, time in business, business and personal credit history, and other factors to determine if you qualify for equipment financing.

How To Find Equipment Finance Lenders

You have several options available for equipment loans and leases.

Banks generally have the best rates, although they also have the most stringent borrowing requirements.

Online lenders are also an option. Some online lenders deal exclusively in equipment financing. Others do not offer true equipment loans but do have general business loans that can be used to purchase equipment. Some third-party online equipment financers also sell used equipment that’s been returned by previous lessees.

You can also use a captive lessor. This is a vendor that offers in-house financing for equipment.

Whatever route you take, make sure that you understand the borrowing requirements before applying.

The Bottom Line On Equipment Financing

In general, leasing is best for equipment that regularly needs upgrading, and a loan is best for equipment that will last a long time while retaining its usefulness.

Remember, you’re not limited to traditional term loans either — lines of credit and invoice factoring are other common ways to finance necessary equipment if you can’t afford to pay out of pocket.

Regardless of which way you choose to finance your equipment, do the math and read over the contract to ensure the terms work for your business.