Understanding Equipment Financing

A Resource For Managers, Business Owners, & Entrepreneurs

Understanding Equipment Financing

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on June 23, 2010

Equipment loans are used for financing a wide variety of equipment such as agricultural equipment, construction equipment, and even equipment working in a factory. This post will discuss equipment loans that fall outside of the Canadian Agricultural Loans Act (CALA) program or the Canada Small Business Financing Act (CSBFA).

Equipment loans have regular instalment payments matched to the business’s cash flow cycle. The repayment period (amortization) on the loan is matched to the economic life of the equipment being financed. These loans will take the equipment being financed as collateral. The bank will not lend the full amount of the purchase but rather 50% to 75% of the purchase price. The lending value is determined by the age and marketability of the equipment. The discounted lending value is meant to protect the bank against the inevitable depreciation of the equipment. The bank wants to make sure that the collateral is always worth more than the value of the loan.

These loans come with fixed or floating rates. Floating rates are based off of the prime lending rate with spreads of 1% or more, depending on the creditworthiness of your business. Fixed rates for equipment are generally higher than mortgage rates. Prepayment of a fixed rate equipment loan may not be allowed or may cause stiff prepayment penalties but this varies from bank to bank.

Dealer financing for equipment can generally be done at 100% of the purchase price. They do this because it is much easier for them to repossess equipment and sell it than it is for the bank, which does not operate a dealer network. Dealer rates may appear to be lower but watch for documentation fees or setup fees that can create an effective rate of interest that is close to that of your financial institution. A dealer may not give the same amount of a discount off of the purchase price for a deal they finance in house compared to a cash purchase. This also adds to the cost of borrowing.

Financing equipment can get complicated so I recommend that you shop around for your financing. Make sure you compare the total cost of borrowing of the various options that are available. Leasing equipment is another possibility. I’ll cover that in a future post.

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