Rising interest rates are throwing a wrench in the plans of some businesses that financed equipment on revolving lines of credit, and they might be delaying activity from other companies that were planning to.

U.S. businesses took on $7.1 billion in new loans, leases and lines of credit to fund equipment in February—4% less than they did a year earlier and nearly 1% less than they did in January, according to data from the Equipment Leasing and Finance Association (ELFA). According to a 2021 ELFA survey, construction equipment is the third most financed equipment type reported by ELFA member companies, accounting for 13.6% of equipment financing new business volume in 2020.

ELFA President and CEO Ralph Petta attributed the slight decline in financing volume this year to geopolitical unrest, rising interest rates, inflation and continuing supply disruptions. He says, “all pose headwinds that bear monitoring.”

At the same time, rising interest rates are causing some companies’ decision-makers to rethink how they financed equipment during the past two years. When rates are low, some businesses choose short-term, variable-rate financing options for their equipment needs because it is the “path of least resistance.”

With revolving lines of credit, businesses can borrow money repeatedly up to their credit limit, while making repayments along the way. For instance, a construction company could borrow one month to purchase a fleet of vehicles and then borrow more the next month for equipment, all on the same revolving line of credit as long as the company has not reached its borrowing limit. This process doesn’t require underwriting, so it tends to be quicker and less work than if the business were to seek a longer-term financing option such as leasing.

Rate hikes are increasing demand for refinancing

Now that rates are rising—with two rate hikes on the books as of May and possibly as many as eight or nine more on the way—companies increasingly are looking to refinance variable-rate equipment loans onto longer-term, fixed-rate equipment financing options. This refinancing, in turn, frees up their revolving credit for other uses.

Plus, unlike using revolving lines of credit, which are general-purpose, equipment-specific financing options can be structured in ways that address challenges that construction companies face. For instance, when companies finance equipment directly with a vendor, the financing might not fully cover the costs of the project, including taxes, freight and installation. By contrast, 100% financing is available when equipment is leased through an equipment financing company.

Another challenge that businesses may face if they finance equipment directly with each vendor is the operational nightmare of having 100 invoices or more to different payees versus payments to one project-based lender.

It’s the same thing for vehicles. If a company is buying 50 vehicles from five different vendors, it could end up with 50 invoices. But with an equipment financing company the purchase is funded over time on one payment schedule.

Used equipment is more difficult to finance

Other challenges that construction companies face include deterioration in equipment value and obsolescence, which make it more difficult for companies to secure financing for used equipment versus new.

When equipment is new, the lender has an invoice and a structure, and it knows exactly what it’s dealing with. When equipment is used, the lender has to go out into the market and research the current value.

The appraisal process takes time and hundreds or thousands of dollars, a cost that is passed on to the customer. Plus, today’s value of some equipment, such as tractor-trailer cabs, won’t factor into the appraisal because banks know it’s inflated. They know that when the supply chain corrects itself, it’s going to become flooded, and the equipment is going to depreciate back to normal and maybe even below normal values.

Altogether with used equipment, contractors could end up with a shorter-term, a higher interest rate or a lower advance. For instance, for some used equipment, come lenders only finance 75% of the liquidation value, plus it’s already depreciated 20%. If the customer had financed that same equipment when it was new, the lender may have financed it 100% for a longer term, and it could have locked the interest rate earlier for a lower rate.

Even with interest rate hikes, the business outlook is optimistic

Overall, despite the headwinds that ELFA noted, the business outlook remains positive, although dampening slightly, according to the Equipment Leasing & Finance Foundation’s March confidence index. The index for March was 58.2, down from 61.8 in February, but any reading above 50 indicates a positive outlook.

Construction companies that want to refinance should not wait. It’s better to start the process now than to wait until after more interest rate increases come. Also, the sooner a company refinances, the quicker the turnaround time so it can complete the transaction it needs to meet urgent business needs.