Pros and Cons of Equipment Loans – Newsweek Vault (2024)

Vault’s Viewpoint

• Equipment business loans are specifically designed for purchasing expensive equipment or tools.
• The equipment purchased serves as collateral for the loan, helping increase loan limits and keeping rates low.
• Companies might also consider alternatives to equipment loans, such as leasing equipment.

What Is an Equipment Loan?

An equipment loan is a specialized type of business loan that can help business owners purchase equipment necessary to run a business. That can include anything from large manufacturing machinery or large trucks to smaller vehicles or even a refrigerator or microwave oven in a restaurant.

How Is an Equipment Loan Different From Other Types of Business Loans?

What sets equipment loans apart from other types of business loans is that the equipment you purchase serves as collateral for the loan. If you can’t pay the monthly bill, the lender could take the equipment purchased and sell it to recoup any losses.

This reduces the risk that lenders face, especially compared to unsecured business loans. That lets lenders offer much larger loans and lower business loan interest rates. Lenders may also have less strict underwriting requirements because of the collateral involved.

Pros of Equipment Loans

There are a lot of good reasons to consider applying for an equipment loan, including:

Easier Underwriting

One of the biggest perks of equipment loans is that they come with built-in collateral. Whatever you buy using the loan serves to secure that loan, placing a limit on the risk the lender faces.

That extra security for the lender means that many lenders offer easier underwriting standards. Where a typical business loan might have strict revenue and time-in-business requirements, equipment loans are often more flexible and accessible to startup businesses and people with bad credit.

Higher Loan Limits

Another benefit of using the equipment you buy as collateral for the loan is that equipment loans tend to have higher loan limits than other types of business loans.

For example, Lendio offers borrowers term loans as large as $2 million but extends that limit to $5 million if you apply for an equipment loan.

Build Your Company’s Credit

Because of the easier underwriting requirements, equipment loans can be a good way to improve your business credit score. If you’re just starting your business, an equipment loan may be one of the first loans you can qualify for. If you make your monthly payments, that will put you on the path toward strong business credit.

Cons of Equipment Loans

Equipment loans aren’t right for everyone. Before you apply, it’s important to consider the drawbacks.

Restricted Uses

The most obvious drawback of equipment loans is that you can only use them for a single purpose: buying equipment. If you’re looking for funding for other purposes, such as buying inventory, covering a period of poor cash flow or buying real estate, you’ll have to look for a different type of loan.

Down Payment Requirements May Be High

Equipment loans help you buy expensive machinery and equipment without having to pay for the full purchase upfront. But that doesn’t mean you don’t need to have any cash on hand.

Many equipment lenders will require a down payment if you want to get an equipment loan. This is especially true if your company is newer or has poor or limited credit. Expect to need 10% or 20% of the cost of the equipment as a down payment.

Costs

When you get a loan, you have to pay back the money that you borrowed. The more you borrow, the more you have to pay.

Given that equipment can be expensive, the monthly loan payments for an equipment loan can be high. Adding to the cost is the fact that equipment loans often have longer repayment terms than other loans. That can increase how much you pay overall because it leaves more time for interest to accrue.

Alternatives to Equipment Loans

If you need expensive equipment for your business, an equipment loan isn’t the only option available. You should also consider these alternatives.

Leasing Equipment

Leasing equipment is one of the most popular alternatives to getting an equipment loan. The key difference with leasing is that you’re not purchasing the equipment that your company will use. Instead, you’re renting it from another company.

Typically, leases have lower upfront costs and monthly payments. However, unlike a loan, you can never pay off a lease. If you use a loan to buy equipment, eventually you’ll pay off the loan and be able to keep using the equipment with no associated loan payments.

Leasing can be a good fit if:

• You want to upgrade or replace the equipment in the short-to-medium term
• You can’t afford the upfront cost of a loan
• You need a lower monthly payment
• You don’t want to be responsible for repairs and maintenance

An equipment loan is a better fit if:

• You plan to keep the equipment for a long time, especially if it will last for longer than the loan’s term
• You can afford the down payment
• You can handle repairs and other maintenance
• You want to benefit from selling or scrapping the equipment in the future

SBA Loans

SBA loans are loans insured by the U.S. Small Business Administration and are typically insured up to 90% of the loan amount to help reduce the risk that lenders face.

This insurance means that underwriting for SBA loans can be a bit less strict than for other types of business loans. But it can take a lot of paperwork and up to 90 days to receive funds.

SBA loans have higher limits than most other types of business loans. For example, SBA 7(a) loans can have loan amounts up to $5 million with repayment terms of up to 10 years if you’re using funds to purchase equipment.

An SBA loan might be a good fit if:

• You can wait a few months to get funding
• You need to borrow a very large amount to purchase equipment
• Your business is new and struggling to qualify with other lenders

An equipment loan is a better fit if:

• You need to get your loan approved quickly
• You have strong business credit and have been operating for a while
• You can purchase the necessary equipment without exceeding the lender’s loan limits

Business Line of Credit

A business line of credit is a flexible loan that functions similarly to a credit card. When you’re approved for a line of credit, the lender will give you a credit limit. You can draw funds from your line of credit multiple times, on an as-needed basis, up to your credit limit.

Like a business credit card, you only make payments and accrue interest when you have an outstanding balance. As you pay down the balance, you free up your line of credit for further borrowing.

Because of their flexibility, many businesses use lines of credit to deal with unexpected expenses or short-term cash flow shortfalls. But you can also use them to purchase equipment.

Typically, lines of credit have lower credit limits than other types of business loans. They may also have higher interest rates compared to a term loan.

A line of credit might be a good fit if:

• The equipment you need isn’t expensive
• You want a line of credit to help with other financing needs
• You have strong credit

An equipment line is a better choice if:

• You need to buy very expensive equipment
• Your credit isn’t particularly strong