One thing that’s helpful in understanding this is to look at money lending as an investment for the lender. If it’s a private lender (like Crest Capital), the lender is lending its own funds. And the rate they charge for the risk they take must significantly surpass whatever they could earn safely. 

To see this in action, look at treasury notes. Right now, a 5-year treasury note is paying mid-4’s to close to 5%. So a lender can put their money there with no risk at all. Why on earth would they ever lend it to anyone for even close to that? The answer is, they wouldn’t. Nor would you. Makes sense, right?

Now look at lenders like banks. Banks (generally) do not use their own capital for lending – they use depositors’ capital, which they pay interest on. So whatever they charge has to make sense financially here, too.  And while individual loans and circumstances could be different, in general terms, any lending needs to be well above what they are paying in interest – it’s the only way a lender can survive.

Next we’ll talk about overhead. Like any business, lenders have overhead, from property taxes to the electric bill and more. But what isn’t known is the sheer amount of legwork required for some loans.  Some of the more exotic loans take a lot of paperwork and back and forth. And any smart lender will do at least a little UCC homework on a used equipment financing deal. This costs time, which equates to salary/money.  

Capital requirements are another “cost of money” issue. Lenders are required to keep a certain percentage of capital on the sidelines (earning next to nothing), and different loans can have higher capital requirements, especially if they are of the riskier type. 

We’ll be going over defaults in detail in another post, but defaults DO factor into the overall cost of funds as well.  

No way around it – money costs money, and it’s going to be reflected in the rate a lender charges.

In fact, this situation can be so dire, equipment financing companies like mine have learned to look for signs of trouble when financing or leasing equipment.

Here are a few things we practice:

• Before a deal even commences, we try and make sure the seller services the equipment. And if they don’t, is there an authorized path to service? And how long is the warrantee? These things all matter – we want to avoid something breaking in 91 days, and nobody wanting to pay to have it fixed.

• Obviously, we will also look at the seller in terms of complaints – a seller notorious for selling junk will probably kill a finance deal.

• While it’s true that in many transactions, we pay the seller in advance (after all, the seller is not interested in offering credit themselves), we do make sure the seller has the financial stature to be entrusted with the funds (no risk the seller is desperate for cash and might spend the money and not deliver the equipment). If the seller is financially weak, we require the equipment be received and accepted by the buyer prior to releasing funds to the seller. This means someone physically receives it, opens the box, makes sure it’s not damaged, plugs it in, tests it, etc. When we get the “ok”, then we pay. This protects everybody from a potentially uncomfortable situation.

• Some finance and lease deals are done on timetabled deliverables (such as developed software). The deadlines and such are written into the lease deal, with pre-specified payments at agreed-upon intervals.

The preceding safeguards are not 100% failsafe, of course – nothing is. But they can go a long way in making a finance deal work. No matter which type of finance transaction you are on, acknowledging and adhering to the preceding will make everyone’s life a little easier (and push the deal through faster.)