Debt can cause stress, especially if you have multiple outstanding loans. So, paying off an equipment loan early can seem like a no-brainer — but you might be surprised to learn there are certain situations when it can hurt more than help.
In this article, we’ll first discuss whether you can pay off an equipment loan early, and then we’ll get into whether or not you should. Ask yourself these questions as you decide when to pay off your commercial equipment loan.
What Type of Loan Do I Have?
Your answer to this question determines whether or not you can save money by paying off your loan early. Different types of loans may not incentivize early payoffs or may even include an early payoff penalty.
Amortizing Loan
With an amortizing loan, you make periodic payments that apply to both the principal balance and interest. Typically, payments on amortizing loans mostly pay down interest during the early part of the term. As the loan term goes on, more of each payment goes toward your principal balance.
Paying off an amortizing loan early can save you from having to pay future interest. However, some lenders include an early payoff penalty in the loan contract since an early payoff will cause the lender to lose out on interest.
Should I Pay It Off Early?
It can be beneficial to pay off amortizing loans early. Check whether your loan has an early payoff penalty built into the loan agreement.
Non-Amortizing Loan
A non-amortizing loan is a type of loan that usually has no fixed payment schedule. Instead, you pay off the principal balance in a lump sum. The amount of interest in a non-amortized loan is fixed, so no matter when you pay off a non-amortized loan, the lender gets the same amount of total interest.
Should I Pay It Off Early?
It may be possible to pay off your non-amortized loan early, but doing so won’t save you any money in interest payments.
RELATED: The Beginner’s Guide to Commercial Equipment Financing
Do I Have Sufficient Funds to Pay Off My Loan?
Once you’ve determined whether you can benefit from paying off your loan early, you need to consider whether you can afford to do so without jeopardizing the financial stability of your company.
I Have Just Enough Funds to Pay Off My Loan
If you tie up all your cash by paying off a loan early, you could put the entire stability of your company’s finances at risk. And even if the worst doesn’t happen, you might end up just having to take out another loan before long when you find you can’t afford to maintain your equipment or acquire new equipment. So, you want to make sure you’re not using all or most of your available cash reserves to pay off your loan early.
Should I Pay It Off Early?
No. Using all your available cash to pay off a loan can jeopardize the financial stability of your company.
I Will Still Have Funds in Reserve After Paying Off My Loan
If you can safely pay off a loan while still keeping a healthy cash flow for your business, it could be worthwhile to pay off your loan early. This is especially true if you have other types of loans or debts in addition to the equipment loan and you want to minimize your debt service coverage ratio.
Should I Pay It Off Early?
It may be worth paying off your loan early if your company will still have a healthy cash flow after the early payoff.
Should I Pay Off a Commercial Equipment Loan Early?
Now that you’ve established whether you can pay off the loan early, it’s time to look at why you want to do so. Even if you have an amortized loan with no early payoff penalty and the funds to pay off your loan early, it doesn’t mean an early payoff is the right move for your business. Whether you should pay off an equipment loan early depends on how it will affect your company’s long-term health.
Valid Reasons to Pay Off an Equipment Loan Early
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- Save on interest: Paying off a loan early can save you money in the long run. If you have the available funds to pay off the loan, the money you were planning on putting towards additional interest is now available for other uses.
- Improve financial strength: Multiple loans can negatively affect your debt service coverage ratio and your business’ credit score. If you want to make your company appear financially stronger to your stockholders or potential new business partners, paying off a loan may help.
- Get peace of mind: Reducing your debt feels good. Getting rid of outstanding debt can open up new options and help you look toward the future.
Bad Reasons to Pay Off an Equipment Loan Early
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- It’s the easiest loan to pay off: If you have another loan that has higher interest rates, paying off that loan before your equipment loan should save you the most money in interest payments.
- You have enough cash right now, but you haven’t looked too far ahead: Even if you think you have enough available cash to pay off your loan comfortably, make sure to think ahead as far as you can and anticipate possible expenses. Using your extra money to pay off a loan turns a liquid asset (cash) into an illiquid asset, meaning you can’t use that money for any other purposes.
- You don’t have much credit history, and you assume paying off your loan will help: For many new businesses, establishing a credit history is a big challenge. Banks and other lenders may hesitate to lend your company money. Once you’ve secured a loan, continuing to make on-time scheduled payments on that loan will help build your credit history more than an early payoff.
Team Financial Group Offers A Variety of Equipment Financing Options to Fit Your Needs
At Team Financial Group, we offer leases and finance agreements that we can customize to fit your unique business needs. We’re dedicated to helping our clients grow and thrive by providing efficient and flexible financing options and personalized service.
Ready to get started? Applying is easy! Just visit our application page, fill out your contact information, and one of our commercial financing experts will get in touch to help walk you through the application process and determine which option is right for you.
If you have questions or concerns you want to address before you begin the application process, we can help. Get in touch with us by calling 616-735-2393 or by filling out our convenient online contact form.
The content provided here is for informational purposes only. For financial advice, please contact our commercial financing experts.