It’s been more than three years since I did a series on reasons to finance equipment, so it seems like a good time to revisit the topic. It’s good to do this every few years, as the economy and marketplace undergo constant change.

To give one good example, many companies put off financing equipment in 2022 (the last time I did this) due to rising rates. And yes, rates rose a lot that year. But today’s economic landscape is much different – rates are holding steady, with most experts feeling some minor cuts are far more likely than rates going up. 

Anyway, it’s a good time to finance right now, and in this next series of posts, I’ll go over reasons why. Off the top of my head, here are a few topics you can expect me to discuss.

Reasons to finance equipment in 2025:

• Growth – Get the equipment you need right now.
• Preserve Capital – Keep your own money for emergencies.
• One-of-a-Kind Deals – The excellent used market warrants further discussion. Don’t miss out.
• Predictability – Use fixed rates to predict costs and expenses.
• Tax Advantages – Both financing and leasing have tax advantages.
• New Technology – Take advantage of new technology immediately.
• Competition – Keep up with competitors or (even better) lap them!
• Pay With Tomorrow’s Dollars – Today’s money is worth more than tomorrow’s. So getting needed equipment today but paying with future dollars is a strong move. Especially with fixed payments.

I can talk equipment financing all day, so I like this particular topic a lot. I also like giving reasons, partially because most of us are taught from a very young age to avoid debt. But using debt, particularly equipment financing, is not only a very healthy and smart business tactic, it’s often THE catalyst to growth. But I’m jumping the gun – that’s for my next post.

Stay tuned folks – more to come!

Defaults are when borrowers, at some point in the loan’s life, cease making their payments. For this post, the reasons why are immaterial – at the end of the day, all that matters is the lender is out not only a (sometimes large) portion of the money they lent, but they are also out of the expected revenue from the interest. Since most businesses use some form of projected/expected income to operate, this is doubly bad for a lender. And no, “writing it off” does not make a lender whole by any stretch.

But it isn’t just the money/revenue lost. Most of the time, there was some form of collateral involved with the loan, which now must be repossessed. This costs money, as someone has to be paid to collect it. One other issue here: Since the borrower is generally in some kind of financial straits, this is typically not a pleasant experience. 

In addition, in most cases, the collateral does not make the lender whole. They still need to sell the item, and they almost never recoup even close to what is owed.

There’s another aspect to defaults that often goes unnoticed by those outside the lending industry: how defaults make a lender look to regulators. Too many defaults will often bring increased regulation on the lender, and increase their capital requirements. Nevermind that perhaps the defaults were an anomaly and not really the lender’s fault. That won’t matter to the regulators; to them, the lender is writing too many risky loans and will be treated as such.

Lenders use an immense amount of data to qualify borrowers, and, much like the insurance industry, attempt to predict default rates based on various lending criteria and borrower/loan profiles. Now, of course, lenders can’t predict which specific borrowers may default, but they do have to honor what the data tells them about the aggregate. These predicted default rates are factored into the lender’s overhead and become part of the rate equation.

Despite the lender’s best efforts and the borrower’s best intentions, defaults in the lending industry are inevitable and must be accounted for.

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.

Risk is one of the largest factors affecting the rates you pay. In fact, nearly all lending rates begin at whatever the Federal Funds Rate is, and are then adjusted upwards based on risk and lender overhead.

But risk is the big one, and it’s also quite variable, with almost all borrower risk profiles being unique, and quite multifaceted.  Of course, on the surface, you would think the borrower’s credit score essentially constitutes the lender’s risk. But it goes a lot further than that.

Indeed, I’m looking at my list of topics for this series:

1.  Common misconceptions about rates. (already posted)
2. The relationship between risk and the rate. (we are here)
3. How loan type and intended use affects rates.
4. Collateral and rates.
5. Internal cost of funds and rates (aka, “how much does money cost?”).
6. Defaults and rates.
7. Credit scores and other risk profiles affecting rates.
8. Benchmark rates and market conditions.

And I can see that numbers 3,4,6,7 are all directly related to risk. #8 also has a little risk in there. #5 doesn’t (and I’ll likely be including lender overhead in that one too).

So yes, risk is a big factor in rates. The more risk (taking into account all of these factors), the higher the rate. That’s the quick answer.

Now someone may ask “well, why is that? Why does the rate go up with more risk? Why does more risk to the lender cost borrowers more?”

Well, riskier loans have a higher chance to default, right? And in the aggregate, this must be taken into account. A lender cannot be profitable otherwise. 

Without getting too deep into the math, lenders use an actuarial approach similar to insurance companies. Just like insurers predict fire claims in certain demographics to set rates, lenders analyze numbers to predict loan defaults based on risk profiles. The thing is, the models cannot predict individual outcomes, so borrowers are categorized by credit score, collateral, loan type, etc.

Now I must be emphatic – loans going bad is a serious topic, as the consequences are devastatingly costly to a lender. Not only do they not get paid back the money they lent, but recouping any funds is difficult and drawn out.

For example, first think about the lender repossessing the item and selling it. All well and good, but this costs money – someone must physically retrieve the item (not always a pleasant transaction), inspect it, repair it, clean it, list it, and sell it. Nobody does these things for free. Plus, the item will certainly have significant depreciation. So repossession falls into the “better than nothing but certainly not optimal” bucket. 

In addition, defaults do not just disappear from a lender’s books – the money owed must be made back from somewhere. Can a lender “write off” some losses? Yea, sort of. But it’s a) complicated and time-consuming, and b) only a fraction of what was truly lost. 

Listen, defaults are always very unprofitable. And the money needs to be made up from other borrowers in the form of rates, which is exactly what we are talking about here. When I talk about risk, I am really talking about expected defaults, and that makes rates go up.

In the end, the rate on any given loan needs to be profitable enough to offset the expected loss for whatever the total risk profile is. Plus, lenders must also account that riskier loans require more regulatory rules (i.e., cash on hand, which we’ll discuss in internal costs). And that costs money as well. 

Like I said, the actual nuts and bolts of the “why” boil down to a complex set of math formulas that take all kinds of factors into account. But for purposes of discussion in this series, just understand that increased risk = increased rate.   

The misconception is the lowest rate is everything. And it’s not even close to being everything. In fact, I would argue that in the amounts we generally finance (typically between $5,000 and $500,000), the rate is, at best, the fourth or fifth most important thing, behind collateral, several restrictions, and terms.

In fact, I know someone is quite knowledgeable about business when their first question is, “What are the collateral requirements?” or “How flexible is the repayment structure?”. People newer to business typically lead off with “What is the rate?”

Here’s a quick example: John and Mike both borrow $85,000 for a delivery truck. John’s rate is 7%. Mike’s is 8%. 

John’s 5-year payment is $1683.10.  Mike’s is $1723.49.

So on the surface, John’s payment is roughly $40 less per month, or $480 a year. Multiply that by five years, and that comes to $2400. 

Ok, it’s not chump change, but it’s not that big of a factor over five years, either.

But, in John’s loan, he had to put up his house as collateral, as well as having a lien on the truck. That’s why the rate was lower – lessened risk to the lender.

In Mike’s delivery truck loan (written by Crest Capital of course), the truck lien itself was the only collateral. 

John risked his home for $2400 over five years. Did he really get a better deal? 

I don’t think he did. Most people (and any spouses/family members also living in that house) would agree. 

As I go through this entire series, we’ll run into a number of these “tradeoffs”. I’ll highlight them with a Tradeoff Alert. 

As this upcoming series will show, there’s a lot that goes into a rate, and there are tradeoffs. And when it comes to small business borrowing, the lowest rate is usually not the best deal.

First, not to pat myself on the back regarding my prediction skills, but I did say back in Feb 2023 that rates would continue to rise for a bit (they did) and then hold fast for a long time (they are). 

Now with every Federal Reserve meeting, the question is “when will cuts start?” 

Nobody knows the real answer, but I’ll say “not for a while yet”. Some optimists were saying we’d have 4-6 cuts this year. That was never going to happen, but now it’s starting to look like we may get one to two at best. And none is a definite possibility.

So why is that? Inflation is proving stubborn, especially the so-called “last mile” to the target of 2% (which may not be realistic). But the second part is, at least on a reported Macro level, the economy seems to be humming along. 

Honestly, I’m not so sure the picture is as rosy as we’re being told it is. To give one example, job numbers have a way of not telling the real story (e.g., people fall off unemployment rolls and are not counted anymore, but still don’t have a job.)  Also, someone with two part-time jobs would usually prefer one full-time job, but the numbers don’t reflect that.

This is all my way of saying: THIS is the environment we have right now, and it’s the one we have to work with. I’ve talked recently about equipment financing and growth and not waiting around for the “economic ok” from the news. Because you’re not going to get the real story.

If your company is doing well, keep doing what is working. In fact, do more of it. Add another crew. Offer more of that service everyone wants. Make the building better. Etc. That’s how you expand when things are going well.

If you are on the other side, and things were better a year or three ago, you should consider changing things up. Offer another / different service. Maybe try serving a different geographic area. Do something. Because things won’t get better on their own. 

The current business environment is what we have, and it will be here for a while. Make it work.

Fletch,

I’ve been reading your thoughts about rates but I’ve been holding off getting new gear because I was too scared to borrow when rates were rising. I clearly should have a year ago but that’s hindsight. But today even though I really need some new machinery I’m still hesitant to commit to a long-term loan because rates could start falling. A friend of mine suggested I lease but I’m hesitant there too. Can you talk me into it?

First of all, smart move in asking The Lease Guy to talk to you about a Lease!

But yes I do understand your dilemma and it’s not uncommon. For people who have held off buying equipment the past year, they are almost to the point where they feel like they must stay the course.  

I will say I don’t think rates are going to lower, so you’re probably safe in just financing what you need. But you asked me to talk you into a lease, so here goes:

Get an FMV Lease, which stands for “Fair Market Value” lease. Take it out for 24 to 36 months. This means you aren’t locked in as long as a traditional loan, but most importantly, it gets you the equipment you need right now. And at the end of the lease, you have the option to buy the equipment at the fair market value. If rates are lower and you like what you have, go ahead and buy it. If neither of those things are true, hey, lease another. 

Now, because an FMV lease might be an operating lease, it could be structured so it isn’t on your books as an asset, meaning you can’t take a Section 179 Deduction on it. However, as it IS an operating expense, you can deduct the lease payments on your taxes. While it’s not as big as Section 179, it’s still pretty attractive.

Plus, with the FMV lease, you’re really only paying for the portion of the equipment’s life you are using, which means your payments are going to be pretty manageable.

Lastly, whatever your feelings are, it’s never a good idea to “need” new machinery or equipment, but not get it. It’s hard to competitively operate that way. So if the lease gets you the equipment now, and you feel good about the financials, there’s almost no downside.

Hope that helps! 

It’s been awhile since I posted about Section 179, so let’s discuss this thoroughly awesome tax deduction.

It’s the time of year when you should start thinking hard about Section 179 – especially if you haven’t bought any qualifying equipment yet. That’s because congress raised Section 179’s deduction to a robust $500,000. This means you can buy equipment now, and write off the entire purchase price this year, for up to a cool half mil.

The amount of money this allows you to keep at tax time can be substantial. Figuring a conservative tax rate of 25%, a $100,000 piece of equipment (thus a $100,000 tax deduction) translates to $25,000 in real dollars that stays in your bank account (as opposed to going to Uncle Sam’s).

You can look at that 25k several ways:

1. If you paid cash for the 100k piece of equipment, you could say you got a fat 25% discount.
2. That 25k can be added to your bottom line.
3. If you financed the 100k, well, I need a little more space, because it’s a big deal…

If you financed that 100k right now (late September), you will likely pay 2-3 payments this year, then get a $25k savings on your taxes. Netted out, this means you paid nothing for the equipment this year.

It gets better – until your payments equal the 25k you saved, you still theoretically paid nothing for the equipment.  So perhaps you get to use the equipment for free all of next year too!

But wait, there’s more!!!

Since from Sept of this year until that 25k is met, the equipment costs you $0 in net dollars. But all of that time, the equipment is being used, generating you revenue. This pushes the time the equipment actually “costs” you money out even further. Depending on how much revenue that equipment generates, your payments may never catch up to the money you kept (the net 25k from the deduction), and the additional revenue generated. So in essence, the equipment was free.

Read that again if you have to. Here, I’ll make a quick math equation:

TS + (NR x T) – TMP = P$

Tax savings (TS) plus new revenue (NR) over the term (T) less Total Monthly Payments (TMP) = Profit (P$)

I know, it sounds too good to be true, but it isn’t. That’s why Section 179 rocks!

As I stated previously, almost all lending rates start out the same, and then are adjusted for risk. This is true with “the big three” of loans that many people get – credit cards, auto loans, and mortgage loans. And they all have different risks to lenders (with credit cards being the riskiest, to homes being the least risky). Let’s look at all three:

Credit Cards – Easily the biggest lending risk out there. This is because they are usually given out unsecured by any collateral. And add to that the things people buy with them have almost no resale value (TV’s, Blu-ray Players, dinner at the Golden Goose, etc.) So the credit card issuer is taking on a ton of risk, which means rates are really high (18-25% typically).

Cars and other vehicles – These are squarely in the middle of the “risk” table. To begin, there is often a down payment required, so the borrower has something in the deal. In addition, in most cases, the vehicle has a fairly robust resale value. Yes, it’s not going to recoup things 100% for the lender (after all, the vehicle is worth less the minute you drive off the lot), but while the loan is active, the thought is the vehicle could be repossessed and sold. So while the lender isn’t happy when they have to repossess (and you are even less happy when the repo man shows up), at the minimum, they are going to get something back. So auto loan rates reflect this “lessened” risk.

Homes – Historically, real estate typically goes up in value. Ok, perhaps that bubble burst in the last recession, but that’s an anomaly – a home and property can almost always be resold. Add in a down payment, and you have a situation where the lender has a much smaller risk. This is why mortgage rates are the lowest of these three loan types.

The above doesn’t include a borrower’s credit score (which matters) and down payment size (which will also matter), but those tend to vary from loan to loan. But barring that, the risk assumed is what makes these three types of loans so different from each other in terms of rates. So that’s why you are paying 20%APR for that prime rib.

So the other day I get asked “Fletch, why are credit card rates so high, higher than things like automobiles and mortgages? Well, the answer is pretty basic (and makes for a good blog post). In fact, it can be boiled down to one simple word: Collateral.

In plain terms, interest rates are partially determined by how much risk is involved in a particular loan transaction. The less risk involved, the lower the interest rate (in general terms).

Now, risk is measured several ways: it’s measured by your credit score, and it’s measured by how easily the lending institution can recoup their money in the event of a default. In terms of credit cards, the second part is the biggest factor in determining interest rates. In short, it is MUCH easier to recoup money on real estate than it is on the DVD player Uncle VISA bought you. In fact, the minute you opened that DVD player and used it, it became generally worthless to the credit card company (ever try to sell a used DVD player?)

And what about last night’s dinner, where Uncle Visa again picked up the tab (nice guy he is, huh?) If you default, can the credit card company recoup that meal? Will they even want to?

That’s the reason credit card rates are so high – there is almost no recourse for the credit card company. If you default on a car loan, well, the car can be repossessed. Yes, it won’t have full value, but it has some value. And a home/property? Again, it holds value far more than a DVD player does.

You can use the above to gauge how much “collateral” will affect the rate – if the lending institution can easily recoup their money, it lowers their risk, and should (in most cases) offer a better rate than something they have no chance (or interest) in repossessing.