How Equipment Type and Usage Impact Your Loan Rate
When businessmen begin to compare equipment loan rates, most of them assume that this rate is determined solely by their credit ratings or bank policies. However, the kind of equipment being purchased and its intended usage may equally influence the interest rate being offered. Industry, equipment models, lifetimes, as well as their estimated residual values, begin to affect the lender’s risk, which ultimately sets the interest rate.
The Risk of Equipment Type and Industry
Based on how liquid and essential a piece of equipment is to an industry sector, lenders classify that equipment according to its degree of risk. Therefore, standard machines (ex. medical imaging equipment, construction machines and manufacturing CNC equipment) are typically classified as Tier 1 or Tier 2 types, resulting in lower equipment loan rates because the resale market for Tier 1 and Tier 2 machines is comparatively strong and there is a good chance that the lender can effectively recover the value of its loan through resale if the borrower defaults.
On the contrary, lenders will classify specialized equipment and equipment built for niche markets as higher risk, resulting in a higher equipment loan interest rate. An example of this would be a custom machine developed for a specific manufacturing process or experimental technology, which will only have demand from one buyer category, limiting resale opportunities.
The strength and stability of the industry also play a large role in determining how a lender will classify equipment and the corresponding equipment loan rates. For example, lenders typically offer lower business equipment financing rates that are recession-resistant (ex., healthcare, logistics, and utilities) than for equipment purchased in industries that are volatile (ex., hospitality and newly emerging tech manufacturing industries).
Brand Reputation and Resale Value
Brands are more important than many business owners think. Big-name manufacturers with an established secondary market make financing terms more attractive. Generally, good brands will continue to have parts availability in the long run, offer easy maintenance through standardization, and retain value in the secondary market; these are all factors that result in lower risk for lenders.
By using branded equipment, business owners may be able to enjoy lower equipment loan rates even if the initial purchase price is high. A high-end brand can often result in lower total financing costs because of better depreciation curves and less lender risk.
On the contrary, less-established brands or off-market imports usually have the effects going in the opposite direction: less resale value confidence, maintenance networks that are difficult to access, and deep depreciation. All these factors increase risk, and therefore, equipment loan rates are higher.
Useful Life and Loan Term Alignment
It is preferable that the lender structure its loans in such a way that the term of the loan will not exceed the remaining useful equipment life. Long-lived equipment, such as industrial presses or a fleet of automobiles, qualifies for more favorable terms or loans with lower rates for a greater number of years.
However, shorter lifetimes mean that the lender’s risk goes up. If equipment can become outdated or unusable before the end of the loan term, this raises lender costs, so they charge higher interest rates. However, equipment that evolves quickly, such as some information technology equipment, may come with shorter lifetimes, thus increasing equipment loan rates. From a strategic perspective, equipment that is more durable and more experienced in terms of its service life will facilitate easier capital costs.
How Residual Value Affects Financing
Equipment with a high degree of resale value typically includes construction equipment, trailers, medical devices, and forklifts, among others; therefore, lenders view these equipment types as attractive due to their established resale values and reliability (i.e., the likelihood of realizing a value through sale at the end of the equipment’s useful life). On the other hand, specialized equipment and equipment that depreciates at an accelerated rate tend to have less resale demand.
Hence, lenders may charge more aggressive interest rates on these types of assets than they do on higher-residual equipment types due to the risk/loss mitigation that occurs through pricing. Understanding the probable end-of-term value will assist borrowers in determining their equipment’s probable place within various rate tiers and enable them to choose equipment with the least possible level of interest.
Smarter Equipment Choice Cuts Financing Costs
While obtaining a loan is a way of acquiring financing, it can take the form of purchasing an asset that can reduce your future financial obligations. To do this successfully, consider purchasing a piece of equipment that has high resale value and is from brand-name manufacturers. Buying equipment that is likely to be durable may also help you secure lower interest rates on the equipment loan.
Additionally, purchasing equipment that holds its value will positively impact your balance sheet. An asset that maintains its value will help improve your leverage ratios and create fewer write-offs when the equipment is subsequently refinanced or resold. Therefore, depending on how much extra it costs to acquire a desirable piece of equipment, the total cost of ownership may actually be lower if the number of loans you will have to pay for the equipment is smaller compared to when you purchase a less desirable piece of equipment.
Conclusion
Equipment selection is also a determinant of equipment loan rates. This is because equipment lenders evaluate equipment industry demand, value, useful life, and salability. By being strategic with equipment selection, businesses will negotiate favorable equipment loans, protect their balance sheet, as well as minimize equipment costs, thus rendering prudent equipment decisions a cost-effective equipment solution.
