How to manage an equipment loan
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The key to effectively managing your equipment loan is planning and forethought, especially looking ahead in your business finances to predict the ebs and flows of revenue. It’s also important that you keep communication open with your lender, asking questions when you don’t understand the loan terms and notifying them of any difficulties.
Let’s dive into ways that you can manage your equipment loan even under less-than-ideal circumstances.
What happens if you don’t pay an equipment loan?
When times are tough and revenue is down, you may have valid reasons for not being able to repay your equipment loan. Understand the process that you’ll go through with your lender if you miss repayments.
- Delinquency. Delinquency happens the moment you miss the first repayment. Your lender will notify you about your status and the amount needed to restore your account to good standing, including any late fees.
- Default. If you fail to make several repayments consecutively, your loan could go into default. Your loan agreement spells out when your loan is considered in default, typically after three to six months of missed payments.
- Acceleration. Since you violated the terms of your loan agreement, the lender can make the entire loan amount due, called acceleration.
- Seizing assets and collateral. Your lender will then pursue your assets for repayment, including any collateral such as the commercial equipment that you used to back the loan.
- Seizing personal assets. Many equipment loans also require you to sign a personal guarantee, which is a statement that you agree to be personally responsible for repayment. If you sign a personal guarantee, the lender can go after your personal assets if you default on the loan.
Understand your loan agreement
The first step to managing your equipment loan effectively is to comprehend how the loan works throughout the repayment process. Your lender should be a resource to walk you through your business loan’s fees and terms so that you know what’s expected.
These common terms may be found in your loan agreement.
- The lender can make the entire loan amount immediately due under certain conditions, such as default.
- The annual percentage rate is an expression of the loan's yearly cost that includes principal, interest and certain fees.
- Event of default
- Default happens when the borrower fails to meet repayment obligations or violates other terms in the loan agreement.
- Loan amount
- The loan amount is the total amount being loaned to the borrower, which doesn't include the down payment.
- Loan cost and fees
- Lenders charge different fees to issue business loans, including an appraisal fee to value your equipment, a credit check fee, a document fee for paperwork and administrative tasks and an origination fee for processing the application.
- Penalty fees
- Lenders charge fees for certain penalties stated in the loan agreement, such as collection fees, late payment fees and non-sufficient funds fees.
- Prepayment penalty
- This penalty is applied if you pay off the loan amount early. This helps the lender recoup the money it would have made if you'd kept the loan for its entire term.
- Repayment term
- The repayment term is the length of time you will repay the loan, such as 24 to 60 months.
Create a business budget and monitor revenue
Your business budget can give you a picture of how loan repayments fit into your cash flow. Essentially, the business budget is a detailed list of all your revenue and expenses. It helps you make informed decisions about new obligations based on your financial track record. It can also predict when you might run short on cash.
If you haven’t started a business budget, take the time to create one since you may need it when applying for your equipment loan. A rundown of the process:
- Estimate your revenue. Gather data that you have about your past revenue — the more data you have, the accurate your future forecasts will be. Look for seasonal trends or indicators that your business is gaining or losing profitability. If you don’t have past records, look at your current sales and contracts for an idea, and compare with averages for revenue in your industry.
- Figure cost of goods sold. If you sell products, you want to see how much profit your business makes. Subtract the total cost of making your product from your revenue.
- Calculate expenses. List all expenses in your budget sheet, including fixed expenses, one-time or seasonal purchases and variable expenses that change from month to month.
- Figure your EBITDA. EBITDA is your net earnings before interest, taxes, depreciation and amortization. This number includes all revenue streams including dividends and interest paid minus operating expenses.
- Find your net profit. Now you can calculate how much you spend on interest, taxes, depreciation and amortization. Subtract that number from your EBITDA to find your net profit or loss.
Keep up with equipment maintenance
Setting up a preventive maintenance schedule for your commercial equipment is an important step in managing equipment costs. In short, it heads off issues with your equipment before they happen.
Preventive maintenance minimizes downtime for unexpected, costly repairs and it helps the equipment hold value for staying in good working condition. In a worst-case scenario, preventive maintenance can keep you from repaying a loan on equipment that you can’t use.
Avoid applying for new debt
Having multiple debts can make managing repayments tricky, especially if your revenue dips or you experience seasonal ebs and flows. Instead, make sure that your current debt helps your business become profitable before taking on new debt.
You can also use your debt service coverage ratio (DSCR) and debt-to-income ratio (DTI) to determine whether you can handle a loan.
- Debt service coverage ratio is a measure of your EBITDA or net operating income divided by debt obligations.
- Debt-to-income ratio shows the percentage of revenue that is your debt repayments.
However, don’t rely solely on these ratios. Consider your business’s seasonality and factors that may affect future revenue before comparing equipment loans.
Build a relationship with your lender
Maintaining a solid relationship with your lender can go a long way with future lending or if you run into financial hardship. Start by making your loan repayments on time and setting up automatic payments so that you don’t accidentally miss a due date.
If you find yourself unable to make repayments, let your lender know right away. Your lender might be willing to work out a plan to get through your hardship. Ways that it may offer debt relief:
- Deferred payments. Your loan repayments will get paused for a specific time. This option works best if you experience a short gap in revenue but expect it to improve in the near future. Deferred payments won’t affect your credit.
- Modified repayment terms. The lender may modify your existing agreement to stretch out your repayment terms and lower your repayments.
- Debt settlement. You negotiate with your lender to pay off less than the loan amount owned. Settlement will significantly affect your credit and ability to get a loan in the future.
Check your credit
To shore up your ability to get credit in the future, check on your credit score periodically and find ways to improve your personal credit score. Many small business lenders rely on your personal FICO score to gauge your creditworthiness, often setting a minimum score of 600.
Some lenders also use your business credit score, which is calculated by the three major credit bureaus, Dun & Bradstreet, Equifax and Experian. Business credit scores use a scale of zero to 100 (zero to 300 for FICO Small Business Scoring Service). It’s rated based on factors like your payment history, length of credit history as well as your business’s size and industry risk of failure.
Depending on your business and market conditions, you may run into a variety of circumstances during the course of repaying your equipment loan. You can head off financial hardship by keeping a close eye on revenue and operating expenses and taking steps to make sure that you make repayments on time. But in a worst-case scenario, remember that you can discuss new repayment options with your lender.
Frequently asked questions
An equipment loan is a secured business loan that uses the commercial equipment as collateral to back the loan. Businesses may need it to buy or upgrade equipment that produces their product or service. When businesses buy equipment outright or with a business loan, they’re investing in a non-current asset, which is considered a long-term asset that can’t be liquidated easily. Investing in non-current assets shows stability and confidence in the business’s future growth.
An equipment loan is usually easier to qualify for than other business loans because it’s a secured loan, a benefit to startups and businesses with subpar credit. Many lenders accept borrowers with a personal credit score in the low 600s, sometimes lower. You typically repay the loan over a period of 12 to 60 months. Since it’s secured, you may also find lower interest rates than a traditional term loan based on your credit.
You can take your equipment loan’s annual interest and depreciation as a tax deduction, although you can’t write off the loan repayments themselves. Simply deduct the interest costs you paid over the course of the year. For depreciation, you can either divide the equipment’s cost over its usable life, or deduct its full cost the first year you place it in service as a Section 179 deduction.