Did I Get a Good Deal On My Equipment Loan?
June 10, 2019
June 10, 2019
Access to efficient equipment can be the difference between you running a successful business â€“ and you closing a failing one.
A big part of that access is getting an equipment loan. If youâ€™re reading this, you probably already have one. But you may find yourself wondering if you got the best deal on your financing. Maybe when you applied, you were focused on the length of the loan rather than the interest rate. Or maybe you were more concerned with how much the equipment actually cost, and didnâ€™t consider other factors. Calculating your equipmentâ€™s Loan-to-Value ratio will help you stop wondering for once and for all whether you got a good deal on your equipment loan.
Letâ€™s start with a working definition. Loan-to-value (LTV) measures the ratio of a loan to the value of whatever asset the loan is funding. To get the ratio, you divide the loan amount by the value of the asset.
The lender uses the value of the equipment to determine what is called the borrowing base, which is the amount of money a company can borrow. For equipment loans, the borrowing base is calculated using a percentage of the market value of the equipment â€“ called the discount factorâ€“ which can be as high as 50%.
A great thing about the LTV is that it is not industry specific; it can be used in gas station financing, hospitality financing, and restaurant financing. Youâ€™ll also hear it used in reference to real estate loans. No matter what industry you are in, if you are looking for an asset-based loan, the LTV isrelevant to your interests. The lower the ratio, the better. To find out why, keep reading.
The main factors that impact LTV ratio are down payment, sales (contract) price, and appraised value.
To achieve the lowest LTV ratio, you could raise the down payment and negotiate lowering the sales price. For example, suppose you buy a piece of equipment that is appraised for $200,000, and the owner is willing to sell it for $190,000. If you make a $20,000 down payment, your loan will be for $170,000, resulting in an LTV ratio of 85% ($170,000 / $200,000). If you increase your down payment to $30,000, your loan will be $160,000, making your LTV ratio 80%. The lower the LTV ratio, the greater the chance your loan will be approved, and the lower the interest rate is likely to be, which is obviously better for your business.
Once the lender has determined the amount theyâ€™re willing to finance, theyâ€™ll tell you about the terms. Loan length can range from 1 to 7 years, depending on the type and value of the equipment. The Annual Percentage Rate (APR) â€“ or the amount of interest you pay â€“ can depend on the size of the loan, the type of equipment, and your companyâ€™s credit standing. Generally, the longer the loan term, the lower the APR, and vice versa.
Is this you? Maybe you made a rookie mistake and financed equipment with a shorter life span than the length of the loan. Or maybe youâ€™re a solid 6 months into paying back your loan and have started looking around to see better rates with other lenders. Whatever your scenario, if youâ€™re not happy with your current loan, itâ€™s time to look into refinancing.
Youâ€™ll have various factors to consider. First, equipment refinancing is available through a range of lenders, including traditional banks, commercial lenders, and alternative lenders. So youâ€™ll need to explore these routes to see which one gives you the best rates.
It is in your best interest to get multiple quotes. Once you have a few quotes to compare, you might need to consider questions like whether you should keep the same length term but at a lower APR. Or whether you should lengthen payback time even more, so you can lower your monthly payments and open up your cash flow. With several refinancing offers, you can weigh the pros and cons of each package.
While traditional banks and commercial lenders often offer the widest variety of loans with the best terms (i.e. lower APRs, more repayment options, and so on), these great terms typically come with strict requirements. Although it is easier to qualify for an equipment loan than an unsecured loan because it is asset based (built-in collateral in case you default), these financial institutions still strongly consider the creditworthiness of your business.
Bank loan APRs can be fixed or variable, with the percentage depending on the loan amount, the loan term, and your companyâ€™s credit standing. Many banks are able to structure the loan based on the useful life of the equipment with a repayment schedule that is compatible with the companyâ€™s cash flow.
Companies that canâ€™t qualify for a bank equipment loan can usually qualify through an alternative asset-based lender, but they can expect a higher APR with less flexibility on payback time.
Over the last few years, the number of non-bank asset based lenders has increased, with many of these lenders willing to take on the financing that was originated at a traditional bank. A primary advantage of working with a non-bank lender is that they offer greater leniency and flexibility in applicantsâ€™ credit qualifications. In some cases, alternative lenders will focus more on the length of time a business has been operating and its annual revenue, than on the businessâ€™s credit score, which may help small companies that have been in business for a long period of time.
Generally, the application and approval process with a non-bank lender is much shorter than it is with a bank. Often it can even be completed in a matter of days, instead of the weeks or months it can take with a bank, making the alternative refinancing path a good option for companies that need to move quickly.