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Equipment Loan Agreement: What to Expect Before Signing
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Equipment for your business can be a big expense, and you may not always have cash on hand to pay the full cost upfront. An equipment loan would allow you to borrow money to cover the purchase, then repay that amount as directed in your equipment loan agreement.
Equipment financing is often an attractive option for business owners because the assets act as collateral on the loan, reducing the risk for the lender and increasing your likelihood of being approved. Equipment leases are available as well if you need items that you plan to replace often. Payments on equipment loans are often manageable, and interest rates could be relatively low.
Your interest rate, as well as your repayment terms and other information about your loan, would be detailed in your equipment loan agreement. We’ll help you better understand what’s included in that document, so you can feel comfortable signing the form.
- What is an equipment loan agreement?
- Difference between a loan and a lease agreement
- Details to check before signing
- Navigating your equipment loan agreement
What is an equipment loan agreement?
In general, a business loan agreement documents the exchange between a borrower and a lender. An agreement would outline the terms and conditions that you would be held to for the length of your loan. The agreement would also spell out what actions would lead to default, such as late or missed payments.
Defaulting on an equipment loan would result in the loss of your assets. Because the equipment secures the loan, the lender could seize those items if you fail to meet the requirements of your loan agreement. The lender could then sell that equipment to recoup some of the costs of the loan.
An equipment loan agreement is usually comprised of several documents that you would sign electronically, said Mike Toglia, CEO and executive director of the National Equipment Finance Association. Those documents could include:
- Security agreement: This would describe the assets that the lender could seize if you default on your loan.
- Conditional sales contract: Upon the sale of equipment, the title would remain with the seller until the purchase price is paid in full, which would be after you pay off your loan.
- UCC filing: A UCC-1 filing would protect the interests of the lender and give them rights to the equipment until you repay the loan.
According to Toglia, a lender would present a loan agreement after you apply and receive approval for financing and the equipment is ready for delivery. You would typically apply for equipment financing after choosing which item you want to purchase. Some equipment vendors, such as business phone system manufacturers, offer in-house financing that you could secure while selecting your equipment, he added.
Otherwise, you would pick out your equipment and then apply for financing from a lender. To obtain an equipment loan or lease, you could go to a bank or a finance company, many of which operate online.
Difference between a loan and a lease agreement
An equipment lease is similar to a loan, but the lender would purchase the equipment and you would pay rent to use it for a set amount of time. At the end of the term, you could either return the equipment or purchase it for a discounted price.
A lease is usually a better option for equipment that won’t last long because lease terms are often more flexible than loan terms and could be adjusted to the life of the asset. At the end of a lease term, you wouldn’t have to worry about owning a piece of outdated or unusable equipment. You could return the asset and lease something new.
You typically wouldn’t need to make a down payment when leasing equipment as you would with a loan. Your monthly payments will likely be lower as well. However, leases come with higher interest rates than loans, making them more expensive overall.
You could choose a capital lease or an operating lease for your equipment. Capital leases are similar to loans and would likely result in ownership at the end of the term. Operating leases are ideal for equipment with short lifespans, as you would return the asset when the term ends. Your equipment lease agreement would outline the specifics of whichever option you choose.
Details to check before signing
Once you sign an equipment loan agreement, you’re bound to the terms and conditions in the document. Before committing to the loan, here’s a checklist of details to consider in your agreement:
- Loan amount: Make sure the loan amount stated in the agreement matches what the lender previously discussed.
- Interest rate: Your interest rate would be stated in your loan agreement. The rate would be based on the value of your equipment, as well as your risk as a borrower, and would affect the overall cost of your loan.
- Repayment terms: The loan agreement would specify how the lender expects you to make payments and how often. You could be required to provide bank account information for the lender to make a direct debit.
- Penalties: The agreement would outline penalties for making late payments, which could include adding unpaid interest to your loan balance. You could also owe prepayment penalties if you make extra payments or pay off your balance early.
- End of term options: The lease or loan agreement would outline the steps to take when the borrowing term ends. You may have full ownership, or you may be able to purchase the equipment for fair market value or a $1 buyout.
- Insurance: Some lenders may require you to purchase insurance to cover any damage that the equipment sustains while you’re paying off the loan debt.
- Maintenance and repairs: The loan agreement would illustrate whether you or the lender would be responsible for equipment maintenance or repairs during the loan term.
Depending on the size of the deal and your relationship with the lender, you may be able to negotiate these aspects of your loan agreement, said Toglia. A larger loan may give you more leeway.
Navigating your equipment loan agreement
In recent years, finance companies have improved the language of equipment loan agreements, often using “layman’s terms” so as not to confuse borrowers, Toglia said.
“The documents have been simplified and are pretty straightforward now,” he said.
Still, you should keep an eye out for any questionable details. According to Toglia, the biggest red flag would be automatic renewals: if a lender includes language in the agreement about automatically renewing your loan or lease at the end of the term, you should find financing elsewhere, he said. You can walk away from the deal before you’ve signed anything.
However, once you do sign an agreement, you will be held to the standards that are explained in the document. You may want to consider hiring an attorney to review the forms if you’re feeling unsure or confused about the terms of the agreement.
When signing an equipment loan agreement, you would be putting your assets on the line. To avoid losing your equipment, be sure to find a funding solution that allows you to finance the purchase and repay your debt on a timeline that works for your business.