7 Ways the Interest Rate Decrease Will Affect Equipment Financing

The Federal Reserve announced an interest rate decrease of 50 basis points, its first rate cut in over four years. In a statement, the Fed noted that the rate of inflation has declined and that the committee will continue to work towards the goal of achieving 2% inflation with maximum employment levels. The following are seven ways a lower rate environment will impact the equipment finance industry:

1. Increase in Demand

The most immediate impact of lowered interest rates is the reduction in borrowing costs for businesses. As borrowing becomes less expensive, businesses may be more inclined to take on new equipment loans or leases. This can lead to a surge in demand for equipment financing as companies seek to capitalize on the lower cost of borrowing.

“We’re in the soft-landing camp and expect lower interest rates to help keep demand for equipment financing healthy, even as the economy is expected to cool,” Leigh Lytle, president and CEO of the Equipment Leasing and Finance Association (ELFA), says. “Credit quality in the industry remains very healthy, with charge-offs low and late payments rising to a level consistent with a moderately cooling economy.”

Companies that previously hesitated to invest in new or upgraded equipment due to the high interest rates will be far more likely to commit to financing because it will be more affordable. Existing customers have an opportunity to increase their commitments and invest in more equipment, and new customers will soon enter the market.

“Part of the reason the equipment finance sector has held up so well during a period of high interest rates is that it’s experiencing positive structural change,” Lytle says. “The supply of loans is broadening, with lending from captives and independents growing quickly as bank lending has remained modest over the last couple of years. There are some signs that the latter may be thawing, providing even more options and further lowering borrowing costs for businesses.”

To Prepare: Equipment financiers can begin broadening their market; this could mean targeting new industries. Earlier this year, the ELFA predicted the construction, machine tools and medical markets would be the leading sectors for 2024. This is backed by Suite research revealing that the construction industry has experienced unprecedented growth, and that equipment finance companies can significantly benefit from the sector if they take the right approach. Companies that aren’t yet established in these leading markets may want to consider taking a look at opportunities there.

“Targeting higher-yielding sectors such as IT equipment can help generate better returns,” Donna Yanuzzi, executive vice president and group head of 1st Equipment Finance, says. “Focusing on high-quality credits and assets — although it may lead to narrower rate margins, can significantly reduce costs associated with collections, liquidation and asset depreciation. No interest rate is ever high enough to offset the liquidation expenses on a transaction gone bad.”

Equipment finance businesses should also look to target small- and medium-sized enterprises (SMEs) or even international markets. Expanding customer bases can help offset the impact of tighter margins, as companies will not be making as much profit off of leased equipment thanks to the lower interest rates.

To reach more customers, leaders should consider establishing or strengthening partnerships with equipment manufacturers, dealerships and vendors. Vendor financing programs can provide a steady stream of businesses, as manufacturers may offer financing in order to sell more equipment when rates are low.

2. Increased Competition and Profitability

The lending market is about to become more competitive. Because capital will be less expensive, more lenders may enter the market. Banks, which began pulling back from the industry at the beginning of the year, are in a particularly interesting position, as bank leaders frequently cited the economy and high interest rates as reasons for reconsidering their commitment to equipment finance in the first place.

“We know that a drop in rates may induce some banks that have pulled back to selectively return to our market,” Kalyan Makam, CEO of Amur Equipment Finance, says. “But, despite any increase in competition, we believe that when you’re consistently solving problems for your customers, loyalty isn’t an issue.”

Makam’s comment is important: customer retention and loyalty are imperative in a competitive market. Additionally, yield reduction on loans often accompanies lower interest rates, which compresses profit margins. Business is about to boom but remaining profitable will be more difficult.

To Prepare: To maintain profitability, companies must focus on improving efficiency, offering value-added services, increasing the volume of deals and differentiating themselves among competitors.

“In a lower interest rate environment, maintaining profitability requires a multifaceted approach,” Yanuzzi says. “While fee income or non-interest income is a common focus in many institutions, simply increasing fees will not be enough. Each transaction should be carefully evaluated and priced based on the specific asset and the quality of the credit involved.”

Equipment financiers should take a hard look at innovation and differentiate their offerings through flexible financing options or more personalized customer service. Particularly as new customers enter the market curious about equipment finance options, companies must be prepared to quickly and seamlessly establish their value proposition and unique benefits to clients. Being easy to work with and offering a wide array of benefits is the first step in standing out among competitors.

Other differentiating factors include:

• A Consultative Approach: Moving from a transactional to a consultative relationship with clients can strengthen loyalty and retention, something the equipment finance industry struggles with. Offering advice on the best financing solutions for specific business needs helps position the financier as a trusted partner. “We personalize our processes as much as possible, asking probing questions to uncover underlying requirements and offering customized financing options, such as TRAC leases for commercial vehicles, balloon financing and skip or seasonal payment structures that align with their business cycles,” Yanuzzi says.
• Loyalty Programs: Introducing loyalty or reward programs for repeat customers can enhance retention.
• Streamlined Operations: Adopting more digital tools and automation can reduce operational costs. Automating credit approvals, customer service and documentation can improve efficiency and enable financiers to handle a higher volume of business without a proportional increase in costs.
• Digital Platforms: Using digital platforms for loan origination, customer onboarding and servicing can enhance the customer experience, making it easier for businesses to apply for financing and manage their loans. A seamless digital process can be a competitive advantage, especially for SMEs that value speed and ease.
• Value-Added Services: Equipment financiers can offer additional services, such as maintenance packages, insurance or extended warranties, to differentiate their offerings and build stronger customer relationships. This helps move beyond price competition and improve margins in a lower-rate environment.

“As for the increase in operating costs, we expect businesses to continue to invest in the labor-to-capital equipment transformation, driving the purchase of automation, robotics, enhanced manufacturing and so on,” Makam says. “Leaders who can adapt their organizations to innovate and improve to build on the wisdom of the prior cycle will be ready to expand their market share as conditions change.”

3. Impact on Asset Valuations

Lower interest rates may impact the value of assets. This could be a benefit to lenders with existing portfolios, as the rising residual value of the leased equipment reduces the risk of losses should a borrower default.

To Prepare: Equipment finance businesses should develop strategies for the resale or redeployment of leased equipment. This can mitigate risk and ensure that, even if economic conditions fluctuate, the equipment finance company recoups value.

“What is very important is to consider the impact that the growing preference for pay-per-use contracts would have on your remarketing strategy,” Juan Neil Dodds, senior managing director for the Latin America region at The Alta Group, says. “Selling used equipment to end users is getting more difficult. Increasing our involvement in the circular economy requires additional care, but developing strong relationships with service providers will provide additional revenue opportunities.”

Developing a keen focus on forecasting the residual values of lease equipment — which is easier to do in a lower interest rate environment — is another important skill for equipment financiers to hone. This will facilitate competitive lease rates while minimizing losses at the end of the lease term. Partnering with experts in asset management or second-hand markets can also help optimize returns on residuals.

“Lower interest rates increase the importance of accurate residual value calculations,” Dodds says. “A higher residual value will have a greater impact in the monthly lease payment; therefore, the market will be more competitive, unmasking tolerances but providing a fertile ground for players that have proper procedures in place that maximize their end of lease returns.”

4. Refinancing Opportunities

Lower interest rates often lead to increased demand for refinancing. This is a huge opportunity for new business. However, it may also result in the early termination of higher-rate loans, another area that could impact profitability for equipment finance companies.

To Prepare: Marketing attractive refinancing packages to businesses with existing loans can reduce costs for borrowers while creating new business opportunities. This can contribute to customer retention, placing equipment finance businesses with this client-centric approach above competitors.

Mitigating the loss of higher-rate interest loans due to refinancing is another important aspect to consider. To do this, equipment financiers can offer clients incentives to keep existing loans, such as extended terms or added services (payment flexibility, equipment upgrades and more).

“As rates come down over the course of the next two years, match funding will be important for many,” Makam says. “Longer-term financing arrangements, interest rate swaps and similar tools may be advisable too. As well, we expect opportunities to expand our syndication partnerships beyond the traditional banking system.”

5. Increased Risk-Taking

A greater influx of borrowers with less robust credit profiles often accompanies an interest rate decline. This may create new business opportunities for equipment financiers who remain cautious as the risk default may rise, particularly if the economic outlook remains uncertain.

To Prepare: Equipment financiers may want to consider reassessing credit risk policies, whether this means tightening underwriting standards or using more advanced risk assessment tools. This can help mitigate the risk of defaults while still pursuing new business.

“Equipment financiers should prioritize maintaining strong credit policies and adhering to a well-defined risk appetite,” Ed Krueger, senior vice president, data and analytics at Channel, says. “While new market opportunities may arise, it’s essential to resist the temptation to overly compromise by approving lower-quality, higher risk overrides. Managing industry, source and high-risk segment concentrations (such as new businesses or lower credit scores) is also crucial for maintaining portfolio health.

Monitoring loan portfolios closely will also help equipment financiers detect early signs of trouble, particularly in industries that may be vulnerable to economic shocks.

“We closely monitor payoff requests and take a proactive approach in understanding the motivations behind these requests,” Yanuzzi says. “If customers are upgrading their equipment, we are ready to finance their new purchases. In cases where it aligns with their needs and our business model, we may consider refinancing options. However, to maintain profitability, we also ensure that prepayment penalties are enforced when appropriate.”

Overall, executives agree: the best approach is to be proactive, not reactive.

“Employing strategies like risk-based pricing can help attract and prioritize lower-risk customers while still remaining competitive,” Kreuger says. “For applicants with weaker credit profiles, financiers should consider adding structural enhancements like down payments, applying risk-based pricing models or seeking additional insights from non-traditional credit indicators, such as asset quality or company financials, to better manage risk.”

6. Impact on Lease vs. Buy Decisions

Leasing, which has experienced a resurgence in the higher rate environment, may become less attractive as businesses may be more inclined to purchase equipment. “For businesses, cash flow is often the deciding factor. The financing option that delivers the most favorable cash flow position, whether it’s leasing or purchasing, will typically be the preferred choice,” Kreuger and Cindy Fleck, managing director, west region at Channel, say. “True leases, which often come with lower monthly payments, may become particularly attractive for businesses focused on cash flow management. However, it’s important to recognize that each business may have different priorities — whether that’s ownership, the ability to use the equipment or securing the best payment terms.”

If demand shifts away from leasing products, equipment financiers will have to adapt by either offering more favorable lease terms or by focusing on service-oriented financing models like equipment-as-a-service.

To Prepare: Equipment finance companies can begin to offer a variety of financing options, such as fixed and floating interest rates, operating leases and capital leases. These can appeal to different business needs and steer the customer back into leasing. Introducing more innovative products, such as deferred payment plans and step-up payment structures, can also attract businesses looking for tailored solutions.

“It’s essential for finance companies to collaborate closely with manufacturers and vendors to develop solutions that deliver clear value,” Fleck and Kreuger say. “Exploring various approaches, including partnerships that share risks — such as residual value or buyback arrangements — can help balance challenges like liability concerns for both parties. When structured around ROI or cost-per-use metrics, these models can unlock significant opportunities, driving both sales and customer value.”

7. Macroeconomic Considerations

Sectors that rely heavily on equipment financing could be positively impacted by the interest rate decrease.

“A drop in interest rates should reduce input costs for sectors like construction, transportation and manufacturing, making it more affordable for businesses to invest in new or replacement equipment,” Krueger says. “With easier access to capital, these industries are likely to increase their spending on upgrades. For equipment financiers, this creates a strong opportunity for portfolio growth as application volumes rise.”

To Prepare: Investing in data analytics will prove to be beneficial in understanding customer behavior, market trends and asset depreciation as the economy undergoes shifts. Equipment financiers that can forecast demand, assess risk and more effectively manage portfolios will have a leg up in booming markets. Plus, analyzing customer data can reveal which segments are most likely to benefit from the lower rates, which allows equipment financiers to target these customers with customized marketing and product offerings.

“By maintaining disciplined underwriting practices, financiers can capitalize on increased demand while managing risk effectively, ensuring sustainable and responsible portfolio expansion,” Krueger says.

Opportunity is Coming

A decrease in interest rates tends to stimulate activity in the equipment finance sector, and more cuts are likely coming in the near future. Opportunity is coming. Don’t miss out.