Equipment Loan Agreement:
15 Things to Check
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- Once you’ve been approved of a loan, the lenders will send an equipment loan agreement for you to review. This document outlines the details of the loan, so it’s recommended that you go over it before fully committing.
- When reviewing the loan agreement, always check whether the details are the same as what you and the lender agreed to upon the initial application. If there are discrepancies, it’s best to contact them immediately for further clarifications.
Large, heavy equipment and machinery can be a big expense, and small businesses may not always have enough cash on hand to pay for them upfront. Fortunately, equipment loans are available to help you afford the assets you need without putting too much strain on your business’ cash flow
Once approved, the lenders will send you the equipment loan agreement. Every small business loan will have one if they approve your application. As a borrower, it’s your responsibility to review the fine print of said agreement and decide whether its terms are favorable or not before signing (or not signing).
That said, reviewing these dense agreements can be challenging and confusing, especially if you’re unfamiliar with a lot of the financing terminology.
In this guide, we’ve created an in-depth check list for the different sections of the equipment loan agreement that you need to thoroughly review before you sign.
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What is an Equipment Loan Agreement?
An equipment loan agreement is a document that lenders put together outlining the details of the equipment financing they will be offering you, including the type of equipment loan, loan amount, repayment length, repayment schedule, fees, what constitutes a default, and more.
Equipment loan agreements typically consist of several documents that you have to review and sign electronically. Those documents include:
- Security agreements – This document outlines the assets the lenders can seize in the event that the borrower defaults on the loan.
- Conditional sales contract – This stipulates that the equipment’s title remains with the seller or dealer until the borrower pays the loan amount in full.
- UCC filing – This document protects the interests of the lenders and gives them the rights to the equipment financed until the borrower repays the total amount borrowed.
The lenders draw up the equipment loan agreement after the application and approval process of equipment loans.
What Should You Review in Your Equipment Loan Agreement?
Suppose you’ve been approved for an equipment loan, and the lenders have informed you they will be sending the loan agreement shortly. It’s vital that you go over the document to ensure that it reflects the terms you and your lenders discussed in the initial stages of your application. Failing to do so can result in serious repercussions, like ending up with a debt you can’t afford to pay off.
You’ll want to check if the terms are the same or similar to what the lenders and yourself agreed to before approval.
- Name of lender and borrower
- Type of equipment loan
- Financing amount
- Equipment ownership
- Loan repayment terms
- Repayment schedule
- Available payment methods
- Late payment penalty fees (if any)
- Prepayment fees (if any)
- Maintenance and repair costs
- Insurance policy
- Default provisions
- End of term options
- Miscellaneous fees
Let’s take a closer look at these items:
1. Does the agreement clearly state who the lender and borrower are?
First off, the equipment loan agreement should clearly state which party is the lender and which one is the borrower. The lender’s legal business name should be written eligibly on the agreement, along with the name of the business owner(s), legal business name, and the name of the representative signing the agreement (if applicable).
2. Is the type of equipment loan you applied for the same as the one listed on the agreement?
The type of equipment loan recorded on the equipment loan agreement should match what you and your lender discussed at the beginning of the application process. You should also be familiar with how the type of loan works – whether you’ll be leasing or financing the equipment, or both.
When applying for an equipment loan, you may come across these four main types of equipment loans:
Finance Lease/$1 Buyout
A finance lease, or also known as a $1 buyout, allows business owners to lease the equipment for a fixed monthly payment with the guarantee that the borrowers can buy the equipment at the end of the lease period for a lower price. The business or lessee will have complete control of the value of the equipment at the end of the lease period.
The most significant feature of the true/operating lease is that the lessee can choose whether they will return the equipment, renew the lease period, or purchase it at “fair market value.” The lender, or in this case, the lessor, also has complete control of the asset’s residual value and can depreciate the equipment.
PUT (Purchase Upon Termination) Option Lease
In this equipment financing option, the business owners have to purchase the equipment upon the conclusion of the lease period, as indicated by the name, “Purchase Upon Termination.” The lenders usually establish the mandatory purchase price, expressed in percentages (i.e., 15% PUT).
The payments for PUT leases are much lower compared to other equipment financing types. The lease payment for PUT is also fixed, meaning it doesn’t change according to the fluctuations in the market.
Unlike the typical equipment financing, wherein the financing company funds an equipment purchase, sale, or leaseback, you can use your existing equipment to generate more working capital for your company. You can use the loan’s proceeds towards any business initiative.
With the sales/leaseback type of equipment financing, you can continue using the equipment, so your productivity doesn’t decline, and you can maintain your revenue. However, if you default on the loan, the lenders will seize the asset and use it as payment.
It’s crucial to be familiar with how the type of equipment financing works as it will have an implication on who gets to own the equipment at the end of the financing period and repayment structure. We definitely recommend asking for your accountant or lawyer’s advice before signing.
3. How much is the financing amount?
The next thing you’d want to check is the loan amount. Again, the amount reflected on the agreement must be the same as the one you and the lender agreed to before approval. If they make changes to the loan amount or you see some inconsistency, you should follow up with them and ask for an explanation. The last thing you want is to get too little or too much of what you actually need.
4. Who will own the equipment?
In equipment loans, the borrowers (or business owners) have two options: (1) the bank purchases the equipment, the business rents the equipment for a set amount of time, and then returns it or renews the lease after the lease period; or (2) the lenders finance the equipment, the business pays for the financed amount in increments within a specific period, and then the business has the option of renewing the lease or buying the equipment by the end of the lease period.
The former would be more beneficial if the equipment being financed could quickly become obsolete, such as computers, X-ray machines, and others. On the other hand, the latter would make more sense if the asset has a long projected lifespan, i.e. construction equipment such as cranes, backhoes, etc.
Moreover, clarifying the equipment’s ownership can also have legal implications. You may not be allowed to make any alterations to the equipment if the bank is listed as its formal owner. Conversely, if the declared owner of the asset is you (the borrower), you’d be responsible for the equipment’s maintenance and insurance costs.
5. How long will the loan repayment be?
In general, lenders will usually structure the equipment financing’s length based on the equipment’s projected lifespan. This means that if an X-Ray machine has an average lifespan of 10 years, the repayment period would also be more or less ten years. However, not all equipment being financed has a lifespan of 10 years. That said, others may have a shorter or longer repayment period.
Essentially, longer repayment periods translate to lower repayments and better chances of managing your cash flow efficiently. Equipment financing with shorter repayment periods could mean that you’ll be paying less on interest. This arrangement could still be an excellent choice, you just have to make sure you can afford the repayments.
6. What is the repayment schedule?
Yet another essential aspect to consider is your repayment schedule which, essentially, will depend on your repayment period length. Your repayment schedule will tell you how often you have to make the repayments for the loan and how much you need to make each payment. Generally speaking, the shorter your repayment period is, the more often you’ll need to make repayments.
For instance, if you have a three-year loan repayment period, the lenders might set up a daily or weekly repayment schedule. Regardless of whether it’s daily, biweekly, monthly or quarterly, you should be aware of the repayment schedule to set money aside and avoid missed payments that can hurt your credit score.
7. What payment methods are available?
As more payment options become more available today, lenders may also offer various payment options to make it more convenient for their clients to make their payments. They could accept cash, check, credit cards, or through other accredited online payment platforms.
When checking your loan agreement, be sure that you’re comfortable using one of the payment methods the lenders outlined.
8. How much interest rate and APR do they charge?
On top of everything else, you have to know what the loan’s total cost would be. This means examining the interest rates and the APR the lenders will be charging.
Your interest rate is basically the cost of borrowing money or using the assets, which the lenders charge on top of the loan amount. It could be fixed or variable. Fixed rates mean that your interest rate will remain the same throughout the loan period. It won’t change throughout the entire loan period. Variable rates are based on the current Wall Street prime rate + 2.5% and can vary depending on how the market is faring.
Your Annual Percentage Rate (APR) is a broader measure of the cost of your financing. It combines interest rates and the averaged fees throughout the loan period.
Check these percentages in your loan agreement to know how much the equipment loan will cost and whether or not you will be able to afford it. The bank may already outline the costs, but it doesn’t hurt to do your own calculations to be sure.
9. Are there late payment penalty fees?
A late payment penalty fee is an additional charge that lenders charge borrowers if they fail to make payments on time. This usually gets added upon the total monthly repayment of the business owner. Late payments encourage the borrowers to pay their debts on time.
All fees, including the late payment fees, should be laid out on the equipment loan agreement. If you’re not sure about it, reach out to the lenders and ask for clarifications.
10. Do they charge prepayment fees?
Paying your loan earlier than the expected date is the best way to save on interest rates. However, as beneficial as it is for you, it could mean a loss of profit for the lenders since you won’t be paying for the interest rates anymore. That said, the lenders could charge a prepayment penalty.
A prepayment penalty serves as the cushion for the lenders in case you decide to pay the loan in full earlier than the set date. The prepayment penalty allows the lenders to receive some of the money that was expected if you didn’t pay the loan off early or incentivize you to stretch out your repayments. Most of the time, prepayment penalties don’t save you much money on avoided interest.
Not all lenders charge prepayment penalties, so be sure to check if it’s in your equipment loan agreement. If so, find out how much, so you’ll be aware of it should you decide to pay the financing earlier.
11. Who will pay the maintenance and repair costs?
As you go through the agreement, you should see a section dedicated to explaining who would be responsible for the maintenance and repair costs of the equipment.
If you’re leasing the equipment and the owner listed is the bank, chances are, they will be responsible for these maintenance costs. However, if you (the business) are the legal owner listed in the title, you would have to shoulder those. Again, you should revisit the ownership section of the agreement to double-check.
12. Who will be responsible for the equipment’s insurance policy?
Equipment, especially large ones, needs insurance to protect the owners from losses during theft or damage while the borrower is still paying off the loan debt. Some lenders may require the borrowers to shoulder this insurance while other lenders will cover it themselves. Regardless, be sure to check for this on the loan agreement so you can prepare for the additional costs or negotiate with the lender just in case.
13. What constitutes a default? What are the provisions?
The equipment loan agreement should define what constitutes as a loan default as lenders may have varying definitions of loan default. Some may consider one missed payment as a serious offense, while others would only consider it a default if the borrower hasn’t been making repayments for months.
Furthermore, the lender may charge a default interest on the borrower in the event of a default payment status. This is usually added on top of the amount of missed payments plus the penalties, if there are any.
The agreement should also contain the contractual obligation(s) the business owners would face if they default on the equipment financing. This could include equipment seizure, late payment fees, and a big hit on the credit score, among others.
14. End of term options
The lenders should be able to outline the end-of-term options available to the borrowers once the borrowing period comes to a conclusion. They could offer lease renewal or give the borrowers an option of buying the equipment for its fair market value at the time of purchase or a $1 buyout.
15. Miscellaneous fees
Lastly, you should go over the miscellaneous fees to know what you’ll be paying for on top of the repayments and interest rates. Most of the time, the lenders will charge maintenance, administrative, and closing fees for your equipment financing.
Sometimes, lenders hide this within the fine print, making it even more vital for you to go over the agreement carefully. Doing so will help you avoid any surprise fees down the line.
Note: In reviewing all parts of the equipment loan agreement, you might want to consider seeking the help of a legal and financial professional. They will be able to review the documents with a fine tooth comb to ensure that you’re getting the best deal based on your qualifications. They can also clarify any terms you’re not familiar with so you can feel comfortable knowing all you need to about the agreement you’re getting into.
The Bottom Line
While it can be tempting to just skim through the agreement and sign, you should absolutely fight the urge to do that. An equipment loan agreement is a legally binding document. Once you affix your signature, you’re agreeing to all the terms and conditions of the equipment financing.
That said, you should take the time to go over the equipment loan agreement and make sure that you understand every term within the document’s fine print. Again, consult a financial advisor or lawyer if it means that you’ll get a better picture of the agreement.
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