How To Manage An Equipment Loan

When determining how to manage your equipment loan effectively, the key is planning ahead. You want to make a plan for your business budget, including your loan repayments, as well as understand the ebbs and flows of your revenue. Ultimately, you need to make sure you have plenty of revenue to cover the loan repayments during all seasons of your business.

You also want to keep lines of communication open with the lender. If you have stayed in good standing with your loan, the lender may be willing to work with you if you run into a financial hardship.

Learn seven ways to manage your equipment loan so that you can stay on top of loan repayments.

7 tips to manage your equipment loan

The best ways to set yourself up for success are to understand what you’re signing and never take out more than you can afford to pay back. Let’s dive into seven ways you can manage equipment loans, even under less-than-ideal circumstances.

1. Understand how much loan you can afford.

You want to estimate the cost of the business loan before you sign on the dotted line to ensure that you can easily make the repayments. First, determine how much money you need to make the business purchase.

Then, use a business calculator to plug in the loan amount and estimated interest rate to see the monthly cost. Add the monthly cost to your budget to see if you can easily manage the loan repayments. Consider whether you can still meet this monthly payment even during slow seasons of your business.

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2. 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. To budget effectively for the equipment loan, you need to see that your business will bring in plenty of revenue to cover the loan repayments.

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.

1. Estimate your revenue. Gather data about your past revenue. The more data you have, the more 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 them with your industry’s revenue averages.
2. 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.
3. 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.
4. 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.
5. 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.

3. Understand your loan agreement

Next, you need to understand 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.

• Acceleration
  

  The lender can make the entire loan amount immediately due under certain conditions, such as default.

• APR
  

  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.

4. Pay down debt ahead of schedule.

If your business has seasons with high profits, consider putting more toward the equipment loan than the minimum payment. The higher payment will help you pay off the debt quickly and will save you money in interest long term.

But understand whether the lender will charge you a prepayment penalty, a fee for paying off your loan early. In many cases, it may still be worth it to pay off the debt even with a prepayment penalty. 

However, if your business typically has slow seasons, you may want to save the extra money during profitable seasons. Then, you can use the savings for loan repayments when business is slow. 

5. Avoid applying for new debt

Having multiple debts can make managing repayments tricky, especially if your revenue dips or you experience seasonal ebbs and flows. Instead, make sure that your current debt helps your business become profitable before taking on new debt.

If you must take on more debt, you can use debt ratios to determine whether you can handle a loan. However, don’t rely solely on these ratios. Consider whether the estimated loan repayments fit in your budget before taking on new debt.

• Debt service coverage ratio is a measure of your EBITDA or net operating income divided by debt obligations. Lenders like to see a DSCR of at least 1.25 when funding new loans.
• Debt-to-income ratio shows the percentage of revenue that is your debt repayments. A DTI of 36 percent or less is considered a healthy level of debt in your business.

6. 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 be 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 owed. Settlement will significantly affect your credit and ability to get a loan in the future.

7. 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.

Some lenders will only offer loans to borrowers with good-to-excellent credit. But some have relaxed eligibility requirements as low as a credit score of 500.

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.

What happens if you don’t pay an equipment loan?

When times are tough, and revenue is down, you may have valid reasons for being unable to repay your equipment loan. Understand the process you’ll go through with your lender if you miss repayments.

1. 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.
2. 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.
3. Acceleration. Since you violated the terms of your loan agreement, the lender can make the entire loan amount due, called acceleration.
4. Seizing assets and collateral. Your lender will then pursue your assets for repayment. The lender may seize any collateral you used to back the loan, such as the commercial equipment you purchased with the loan.
5. 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.

Bottom line

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 budgeting for loan repayments and keeping a close eye on revenue to ensure you can make payments. You can also save money during profitable seasons to pay for expenses when things are slow. But in a worst-case scenario, remember that you can discuss new repayment options with your lender.