As a small business owner, obtaining capital for your business is a top priority. But not all business loans are created equal in terms of what they’re designed to help you do. 

If you’re looking to purchase equipment to run your business, equipment financing is your best option. Here’s what to know about what equipment financing is, how it works, how much it costs, and the pros and cons to consider before you apply.

What Is Equipment Financing?

Equipment financing is a type of small business loan designed to help you purchase equipment to help run your business. 

Examples of things you can buy with this type of financing include machinery, office furniture, medical equipment, heavy-duty vehicles, commercial ovens, and more. 

The amount of funding you qualify for is typically based on the value of equipment you’re purchasing with the loan.

You can typically get an equipment loan from a traditional bank, credit union, or online lender.

How Equipment Financing Works

An equipment financing loan is a secured loan, similar to an auto loan or mortgage. This means that the equipment you’re purchasing is used as collateral. If you can’t make your payments, the lender may seize the asset to recoup the remaining balance.

The amount you qualify for will typically be less than the value of the equipment. For example, if you’re purchasing some farm machinery worth $60,000, you may qualify for a $48,000 loan, which means you’ll need to make a 20% down payment to get approved.

Additionally, the term of the loan typically matches how long you plan to use the equipment. If you pick a repayment plan that’s too long, you’ll end up making payments for something you no longer use. Repayment plans can range from one to 25 years.

Because this type of financing is secured by the collateral you’re purchasing, it’s typically cheaper than other forms of business financing that aren’t secured. Traditional banks typically provide the best interest rates, but they also have the strictest credit standards and funding can take several weeks. 

Online lenders may be a better fit if you need a faster turnaround time on your funding or don’t meet the eligibility requirements from traditional lenders. But you may end up with a higher interest rate in exchange.

Typical Equipment Financing Costs

Depending on where you look, equipment financing interest rates can range from 2% to 30%. Again, traditional lenders, like banks and credit unions, tend to offer the lowest interest rates while online lender rates can be higher.

However, your rate will also depend on the type of equipment you want to purchase, your time in business, your annual revenue, and your business credit history. 

For example, you may need to have at least two years in business and $250,000 or more in revenues to qualify with a traditional bank. 

Regardless of which type of lender you apply with, the better your track record in these areas, the better your odds of getting approved with a low interest rate.

In some cases, you may also need to provide some information about your personal finances. That may include tax returns, your personal credit report and score, bank statements, personal debts, and more. 

Some commercial lenders may also require a business plan to show how you plan to use the equipment to build your business, along with your financial projections.

To give you an idea of how much an equipment loan will cost you in the long run, let’s say you finance a heavy-duty vehicle for $75,000 over 10 years with a 7% APR. 

Your monthly payment would be $870, and you’d end up paying $104,400 in total over the 10 years — that’s $29,400 in interest.

Equipment Financing Pros

There are many different benefits to using equipment financing to help build your business:

• Can be affordable: Because most equipment loans are secured, they typically carry lower interest rates than their unsecured counterparts. If you’re looking to minimize your costs and you qualify, this could be a much better option for your business than a standard term loan.
• You’ll own the equipment: Once you’ve paid the loan in full, you’ll own the equipment outright, giving you some flexibility. If the equipment is still in good working condition, you could even sell it and lease it back from the buyer to get an influx of cash.
• Can help build business credit: You may already have a good business credit history, especially if you’re getting your loan from a traditional bank. But even then, making your payments on time can help you continue to build and maintain a good credit history for your business, which can make it easier to get approved for other types of business financing in the future.
• Interest and depreciation are tax-deductible: As with other small business loans, the interest you pay is considered a business expense and, therefore, tax-deductible. Additionally, you’ll be able to deduct depreciation of the asset on your tax return. Consult with a tax professional to determine the best way to approach depreciation.

Equipment Financing Cons

Although there are some clear benefits to using an equipment loan, there are also some potential pitfalls to keep in mind:

• Your loan may outlast your equipment: If your equipment breaks down or fails before you’re done paying off your loan, you’ll be making payments on an asset that’s no longer helping your business.
• Can require a high down payment: If you don’t have enough cash on hand to make the required down payment, you may be forced to pursue a more expensive financing option like an unsecured loan or line of credit.
• More expensive than buying outright: Using financing in your business as leverage is generally a smart move. But if the interest rate is high and you have enough cash to pay for the equipment in full, it may be better to avoid expensive debt, especially if you’re just starting out.
• Missing payments could damage your credit: Just as on-time payments can help build credit history, missing a payment or two could have a negative impact on people’s business credit scores. In cases where the lender requires a personal guarantee, it can also impact personal assets and credit scores. 

Build Your Business Credit to Have More Financing Options

The best interest rates on equipment financing necessitate a strong track record, including a strong credit history. If your business credit score isn’t where it needs to be, consider taking the time to build your credit before you apply for equipment financing.

One way to do this is with the Credit Strong business credit builder account. 

Unlike a traditional loan, Credit Strong deposits the loan funds into a separate account and locks them while you make payments. Then, once the loan is paid in full, you’ll get the loan funds, which you can use however you want.

Credit Strong offers a 60-month and a 120-month term, and your monthly payments will be reported to the commercial credit bureaus Equifax and PayNet — and soon, Experian and SBFE. 

You can qualify for a Credit Strong credit builder account if your small business is at least three months old. 

When you apply, there’s just a soft credit check, which won’t impact your credit score. There is interest on the loan, but over time, you’ll be able to establish a solid business credit history as a result.

The Bottom Line

Equipment financing can be a great way to purchase the equipment you need to build your business. However, it’s important to take your time to shop around and compare several lenders to determine the best fit for you. 

If you don’t need to make the purchase immediately, consider taking steps to build your business credit so that you can improve your chances of securing favorable financing terms.

CreditStrong helps improve your credit and can positively impact the factors that determine 90% of your FICO score.

Start Building credit today