When discussing a possible equipment loan, many people quickly ask some combination of these questions, “What is the interest rate?”, “How much is my monthly payment?”, and “How many months can I have to pay it off?”.
An immediate answer to these questions is not readily available because so much information goes into figuring that out.
And there are many things that factor into a lender's decision process when they formulate the terms for a specific loan. These factors include:
- Amount financed
- Down payment amount
- Equity position
- Age of the equipment (if it is used equipment)
- Equipment’s expected lifespan
- Equipment type
- Equipment brand
- Equipment usage
- Credit history of the borrower
- Payment timing
But how do these affect the loan term decisions and why do they matter?
Amount Financed and Down Payment
The amount you finance is basically the purchase price of the equipment less any down payment you make. Most loans also include some fees - documentation, origination, application, etc. Some lenders require these to be paid upfront, and some allow you to build them into the amount financed. The easiest way to reduce the amount financed is to increase the down payment.
Equity Position
A lender prefers to have equity built into the transaction upfront and must have it built over time. The larger the down payment, and/or the shorter the length of the loan, the faster equity builds because there is less interest charged over time, so more of the payment goes to pay the principal. This is also helpful for the borrower. If you need to sell the equipment before the loan matures, you want to make sure that the amount you sell the equipment for is greater than the amount you still owe on the loan.
If you are converting a rental to a purchase through a rental purchase option (RPO), you should already have equity built into the rental payments, which could be used as the down payment on the loan.
Equipment Age, Type, Brand, Usage, Life Expectancy
Many purchasers prefer a longer term, which spreads the payments out longer, resulting in lower monthly payments than a shorter term.
But term is also a function of the expected lifespan of the equipment. Some equipment simply has a longer expected lifespan. For example, an all-terrain crane may have a 20-year life expectancy, so it could be financed for longer than a dump truck with a ten-year life expectancy.
For a used piece of equipment, the lender will look at the age of the equipment, how much the equipment has been used (mileage or hours), as well as the condition of the equipment. They also consider current pricing for equipment of similar age and usage. If the purchase price is higher than the average of similar age and usage, the lender will require a shorter term to ensure that equity builds more quickly.
For example, a two-year-old truck with 200,000 miles on it will most likely require a shorter term than a truck with the same age and only 100,000 miles on it, simply because the life expectancy, in years, of the higher mileage truck is not as long as the lower mileage truck.
Equipment type, brand, and usage can also play a factor. Top tier brands may hold their value longer than lower tier brands so could conceivably be financed for longer.
Equipment usage can come into play. For instance, a sleeper cab truck that will be driven by long-haul team drivers will run more miles in a shorter time period than a truck being driven by a single driver. Another example is a dump truck. If used for heavy aggregate hauling, it's likely to experience more wear and tear than a truck hauling dirt or sand.
Credit History of the Borrower
General economics (prime rate and inflation rate, for example) aside, the interest rate is most affected by the creditworthiness of the borrower. Creditworthiness can be partially determined by a credit score or a credit reporting agency. For businesses, this can be Dun & Bradstreet, Paynet, etc. These ratings are determined by payment history, total outstanding debt, length of credit history, etc. The lower the credit score or credit rating, the higher the interest rate.
At CCG, we are more interested in the character of the borrower than we are in the credit history of the borrower. If there have been issues in the credit history, we want to understand what happened, why it happened, and how the situation was addressed.
Payment Timing
Quite often a borrower is more concerned about the monthly payment they need to make, rather than the length of the loan or the interest rate. This is actually a good way to think when considering an equipment loan. Borrowers concerned with payment amounts are looking at sustainable cash flow and what makes sense for their business.
Some companies that utilize heavy equipment experience seasonality in their business. Some lenders are willing to work seasonal skip payments into their repayment agreements. This can also help with cash flow but will increase the amount due on the monthly payments (to offset the months when payments are not required).
There is typically no fixed methodology for determining in advance, the actual terms of a loan. You will need to discuss options with your CCG representative and provide them with the goals for your business so they can configure a loan that works best for your short-term and long-term success.
