Everything You Need to Know About Leasing and Buying Equipment with Good or Bad Credit
So you’ve decided that you need to obtain a new piece of equipment for your business. Taking the time to evaluate your options and consider the alternatives is essential in making the best financing choice. Some of you reading this may have obtained equipment in the past, and for some of you this will be the first time down this road. The purpose of this article is to cover each of the steps, from start to finish, to make sure you’re prepared to make the best decision for your company’s future.
Determining Your Monthly Budget
If you’re here reading this, it is likely that your intentions are to either obtain a loan to purchase a piece of equipment or to enter into a lease. Either way, if you the lease the equipment or purchase with a loan, your company will have a monthly payment that has to be paid back towards that debt. It’s important at the outset to take some time to determine what an appropriate budget for that monthly payment would be.
In most cases business owners want to obtain new equipment because it presents the opportunity to grow their business and increase their monthly revenue. Hopefully this equipment will be generating more money for you each month than it costs to pay for it. As long as this is the case the equipment will be paying for itself.
That said, it’s important to consider each of your alternatives. Some of the equipment options you explore might be a little too pricey. The newest and best equipment is always appealing because it has the latest technology and most attractive features. It will also cost the most. On the other hand, looking only for the cheapest, most beat up equipment can come back to haunt you as well if it turns out it isn’t reliable enough to get the job done or doesn’t represent your company’s image in the best way.
Oftentimes your best option will be someone in the middle – less expensive than the most state of the art equipment available, but with more features and reliability than the cheapest option you can find. Taking the time to research and consider your options will help to ensure that the best decision is made going forward.
To get an idea of how much a piece of equipment may cost to finance you can use the calculator below:
Determining your Financing Rate Options:
Part of what determines your financing rate will come down to whether your equipment is purchased or leased. If the equipment is purchased with a loan then the loan will have an interest rate, and if the equipment is leased there will be a lease factor. There are benefits to each of these avenues which will be covered a little later on in this article, but now we will go into what factors the lender will consider in determining financing eligibility and the overall rate.
- Equipment Price
The first factor that will go into determining your financing rate is the price of the equipment. A general rule of thumb is that the larger the equipment price is, the lower the financing rate will be. This makes sense if you consider that the lender generates more interest return and therefore more profit on a larger loan versus a smaller loan. For instance:
Loan A: $100,000 @ 10% interest = $10,000 interest per year
Loan B: $20,000 @ 10% interest = $2,000 interest per year
You get the idea.
Since the lender earns more with a larger loan they can afford to offer lower interest rates the higher the loan amount gets. Conversely, as the loan gets smaller, the lender has to charge higher interest rates for the transaction to be worth their time. Once the loan or financing amount gets too small the lender will decide it’s just not worth the trouble. This is what they’ll refer to as their minimum loan amount or minimum financing amount.
Keep in mind, even though you may get a lower interest rate with a larger loan you’re still going to be dealing with a higher monthly payment than you would with a smaller loan even though the interest rate is higher. For instance:
Loan A : $50,000 @ 8% for 60 months = $1,013.82/mo
Loan B: $40,000 @10% for 60 months = $849.88/mo
So while it’s nice to have the lowest rate available, just remember a lower rate does not necessarily translate into a lower payment if a larger loan amount is required.
2. Age of Equipment
The age of the equipment you’re looking to acquire is the next factor which will affect the financing rate. In general you will receive a lower financing rate with new equipment versus used equipment. There are a few reasons for this:
a) New Equipment Costs More
As we saw in the previous example larger loan amounts typically receive lower interest rates, so if new equipment costs more it will likely require a larger loan amount which will in turn generate a lower rate.
b.) New Equipment is more reliable
In general new equipment is less likely to break down. When equipment breaks down it can leave a business owner unable to generate revenue and therefore more prone to a payment default. Charging a higher interest rate on older equipment helps the lender to offset some of that risk.
c.) Equipment Depreciation
As older equipments depreciates in value it can become increasingly difficult for a lender to recoup their losses if a borrower were to default on their payments. Any amount that a lender is unable to recoup must then be written off as a loss. Higher interest rate charges help to mitigate that risk with older equipment.
3) Credit FICO score
Credit scores are almost always going to play a significant part in determining financing rates and eligibility. Lenders may vary in how they determine each of their tiers for Excellent, Good, Fair, and Poor credit, but here is a general guide to keep in mind:
Excellent FICO Score: 720+
Good FICO Score: 675-719
Fair FICO Score: 620 – 674
Poor FICO Score: 619 or less
Obviously higher credit scores will typically translate into better loan offers and lower interest rates. When applying for financing opportunities it is customary for your credit score to be pulled by the lender in order to generate a pre-approval with lender terms. While a credit score inquiry does have a slight effect on your credit score it is nothing to be concerned about as long as you are not having your credit pulled excessively by many lenders over a short period of time.
4) Time in Business
The longer your company has been in business the better the terms you will likely receive in a financing agreement. This is because the failure rate for new businesses is high. Some estimates claim that 75% of new businesses will eventually fail and that the failure rate is especially high within the first two years. That is why some lenders require that a company has been in business for at least two years before they will consider lending to them. There are financing opportunities available for new businesses but the interest rate or lease factor will typically be higher.
Leasing Equipment vs. Purchasing Equipment
There are a number of factors to consider when contemplating whether to lease or purchase the equipment your company needs. Here are a few of the main questions we encourage business owners to keep in mind when making this decision:
- Do you plan to keep the equipment in question long term or short term?
If you can envision the equipment serving your company’s needs indefinitely into the future then a purchase loan may be an appealing option. Once a purchase loan has been paid off the equipment if yours for as long as you like. Some owners like the flexibility owning equipment gives them. For instance they can choose to sell the equipment themselves later or trade it in on another piece of equipment.
Leasing provides some appealing features as well. Most leases will offer an option to buy at the end of the lease which gives owners the flexibility to decide later if they’d like to keep the equipment long term or just walk away from it with no strings attached. If there is uncertainty as to how your company’s equipment needs would best be met several years down the road then a lease may be the answer.
2. Will the equipment become obsolete?
If the equipment you’re looking to obtain has a tendency to become obsolete quickly – technological equipment would be a good example here – then a lease might make more sense. This would allow you to update to more current equipment at the end of each lease term with no issues.
3. Do you have funds for a down payment?
Equipment leases can often be obtained with no money down, while purchase loans are typically going to require a down payment of some type. If funds for a down payment are scarce this may be a sign that an equipment lease will be the best course of action.
4. What are your business cash flow needs?
Typically leasing equipment will require less cash out of pocket up front. This can be a big help if keeping as much cash on hand as possible is important at the moment for the business. The tradeoff is that leases tend to cost more overall in the long run than a purchase, but the additional expense may be worth it if the cash flow saved today creates valuable opportunities for the company.
Dealing with Less than Perfect Credit (Or Bad Credit!)
If your credit is not the best, there are additional ways to boost the strength of your application. If one or more of these options may be available to you keep them in mind if your credit score comes back at a lower level.
1. Can you get a cosigner?
If someone with better credit is willing to co-sign your application this may provide a boost to you application in the approval process. Having a cosigner on an application gives the lender two times the assurance that payments will be made on the lease or loan.
2.Can you put down a larger down payment?
A larger down payment means the lender can finance a smaller overall amount for a lease or loan. This obviously equals less risk for the lender, and will allow them to consider lower credit score applicants.
3. Do you have collateral?
If you have equity in a vehicle or property that can be offered as collateral the lender will feel safer extending financing to applicants with lower credit. That way if there is a default on the payments the lender will be able to recoup part or all of what’s owed to them from the collateral attached to the agreement.
4. Do you have strong monthly financials?
If your company can show bank statements with strong consistent revenue this may also be a significant factor in compensating for a lower credit score. At the end of the day financing payments are made with dollars, not credit scores, so if the lender is satisfied that there is an adequate, consistent flow of revenue coming into the business this will help them approve the application.
So your credit is less than perfect or just plain bad…now what? There are steps you can take to identify the issues that need to be addressed to get your credit back on track.
1. Make sure to check your credit at least once a year.
All consumers are entitled to one free copy of their credit report each year. Reviewing your credit gives you the opportunity to check your score, as well as to see if there are errors on the report that are bringing your score down. Identifying errors early will give you the chance to address and fix them now, as opposed to discovering them when having your credit run for a financing approval. Being proactive in advance and addressing issues that exist can be the difference between being approved or denied on a credit application later.
2. Try to keep credit account balances under 50% of your credit limit
When credit account balances exceed 50% of your credit limit it begins to have a negative effect on your credit score. If balances reach the credit limit – or worse, exceed it – the effect can be extremely negative. It is far better to owe $5,000 each on two credit accounts with a limit of $10,000 each than two have one $10,000 account maxed out with another $10,000 account with a $0 balance. That may seem odd since both scenarios have the borrower owing the same amount to creditors, but the effect they have on the credit rating is vastly different.
3. Be mindful of credit inquiries
Some borrowers are terrified of having their credit run since they believe it lowers their score. While running a credit report can result in the loss of a few points, it’s important to understand that credit scores must be run in order to qualify for financing. That said, there’s no need to have credit run excessively. When looking for financing options it’s advisable to limit credit inquiries to three or four at most. Investigating financing options with three or four lenders should be sufficient to get an idea of what options are available for your current situation. Going beyond that is typically excessive and could have a detrimental effect on your credit rating.
4. Use it or lose it
When creditors extend credit to a client they typically want to see it being used. If a credit source goes too long without being used, the creditor may choose to close the credit line. To prevent this from happening it’s advisable to use each of your credit sources from time to time to show the creditor you haven’t forgotten about the credit source available to you and can be the difference between an account being left open or closed.
Below are some helpful links to further educate you on topics that we discussed. We hope this helps!