Before you sign on the dotted line, make sure you understand the many factors that impact the cost of financing your equipment … beyond the rate. One of the biggest components to grasp is the early payoff structure.
By Jim Peach
We all get excited when we find the perfect “thing” to buy. Whether it is the latest tech gadget, fun gift or favorite snack, sometimes we lose ourselves in the adventure and let our emotions take over, regardless of the size (or investment) of the purchase.
This same sense of euphoria can also occur when purchasing a new piece of equipment. Maybe you have been searching for the “right” used vehicle for months or suddenly find your dream machine at auction—and now you are ready to buy using financing—and you are pumped!
Before you sign on the dotted line, though, do your future self a favor by truly understanding the many factors that impact the cost of financing your equipment … beyond the rate. One of the biggest components to grasp is the early payoff structure.
What Questions Should I Ask?
There are some questions you should ask prior to finalizing any financing agreement, especially as it relates to an early payoff. We will walk through some of these questions—including which are more effective than others—to best prepare your small business for entering into a contract.
The Semantics of “Early Payoff”
If a financing contract is set for a 60-month term, sometimes customers inquire about paying it off early. Attempting to better understand the terms of the contract upfront, customers often ask the question: “Is there a pre-payment penalty?” While this might seem savvy on the surface, the answer could be misleading.
The answer to this question could be “yes” or “no” depending on the terms of the contract; however, answering “no” does not necessarily mean you will save money. Here is why: many equipment finance agreements stipulate that the customer is responsible for the full payoff (including interest) regardless of the payoff date, so there is never really any opportunity to save money.
Instead, the question we encourage you to ask is: “Will I save money if I pay off early?” By posing this question, you will get a cut-and-dry “yes” or “no” answer. It is essential to understand how this question appears in your equipment finance contract, so there are no surprises a few months or years down the road when you attempt to pay off your purchase.
Many might ask: “Why wouldn’t businesses want their money paid back sooner than the predetermined schedule?” By including interest on your piece of equipment, that is how financial institutions make their money. By paying your loan off one year early, they are losing 12 months of interest. That is usually why a pre-payment penalty is in place so the lender can recoup all the interest that was owed when signing your contract.
Other Forward-Thinking Questions to Consider
• “Does the loan amortize?”: With an amortized loan the majority of your payments go towards the interest on the loan. As time passes, the payments are applied to the principal. By looking at your amortization schedule, you will be able to see how much of your payments are going towards principal and interest. That being said, being able to pay down your loan early may or may not save your business money in the long run.
• Will prepaying affect my taxes?”: When making an equipment purchase for your business, you can declare the interest on your loan as a deductible on your businesses tax returns. By paying off your loan early, avoiding future interest, it may result in losing a portion of your deductible. Do not hesitate to not only ask your finance provider, but also your accountant if this could become a factor in your pre-payment decision.
• “Are there additional payments due at the end of the term?”: If you do decide to pay a loan off early, it is good to know whether you will incur any additional fees or extra payments at the end of the term in order to close the loan. It is best to find out before finalizing the agreement to manage your expectations down the road.
• “Are there conditions that must be met to get an early payoff?”: The answer to this question has to do with how the contract is written. Some contracts have conditions that must be met for an early payoff to occur. Often, contracts require that you never make a late payment, others are contingent upon a credit review or only allow early payoffs if you are financing your next piece of equipment with the company. Be sure to read the fine print and ask questions when it comes to these “contingencies.”
• “How is the payoff calculated?”: When asking this question of the lender, the answer should be very straightforward; if it is not, that is a red flag.
Figuring Out What is Best for Your Business, in the Long Run, is More Valuable than a Short-Term “Fix”
In some instances, early payoff makes financial sense for a business, especially in the following scenarios:
• Needing new equipment fast—Paying off your loan early could benefit your business if you are looking to purchase more equipment. Depending on how quickly you need a new or used piece of equipment, having existing debt could hurt your chances of getting approved or affect your interest rate. When lenders look at your business credit and find a high debt to equity ratio, you might consider paying off your loan and accepting a pre-payment penalty—if there is one per your contract—should this help you secure your next loan.
• Additional cash flow opportunities—Before paying off your loan early because you have the funds, consider if it is in the best interest of your business. Decide what your business will do with the extra cash flow. Whether you want to put it towards hiring a new employee, purchasing new or used equipment, or just as a cushion during a slow season, it is vital to have a plan in place to ensure pre-payment makes the most financial sense for your business.
Understand Your Contract Structure
Before committing to any financing agreement, make sure you understand the contract structure. As mentioned earlier, many factors impact the cost of financing your equipment; if you do not understand something, ask! Choosing the right finance partner could have a significant impact on your business growth. We encourage you to shop around to understand what different institutions can offer when it comes to understanding early payoff. | WA
Jim Peach, CLFP, is VP of Sales and Marketing at Oakmont Capital Services. He has more than 15 years of experience in the equipment finance industry. Prior to joining Oakmont Capital, Jim worked 14 years at Stearns Bank N.A. Jim started at Stearns Bank as an account manager and held many roles during his time there including client relations, business development, third-party origination, equipment valuations, off-lease equipment sales and VP/ Sales Manager. He can be reached at (877) 701-2391, e-mail [email protected] or visit www.oakmontfinance.com.
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