- In Some Financial Markets — You Don’t Have A Lot Of Control!
- In The Financing Market – There Are Ways To Come Out Ahead!
- It does not need to be a guessing game!
The lifeblood of any business depends on the money aspects of it, and is the reason why we work. While the majority of your counterparts in trucking are highly motivated and self-starters, they lack some of the basic skills in starting and managing their businesses.
The usual scenario is that they get equipment using their own assets, through sponsored / internal programs, or using financing organizations with very high rates. Next, as the cash flow establishes itself and the bank account starts to grow, a pickup or boat gets purchased.
Since they are “independent” operators, they take the loads they want, when they want, but also want time off for personal activities.
At some point in the future, something happens that requires cash (tires @ $300+ each, payroll taxes, an engine overhaul @ $10,000+, etc.). Next, comes a cash crunch followed by repossession, Chapter 11 or a Chapter 7 bankruptcy filing.
While many good operators have been this route, either poor payment histories or a bankruptcy filing has marred their credit rating. These individuals then have to take even more unconventional routes to get back into the business.
In talking to many people in the industry, we have found that the true truckers either have been an independent contractor, or want to become one. It is possible to avoid this happening in your business.
HOW YOU CAN TAKE CONTROL
The following was put together from a variety of industry sources, input from a number of fleets and individual operators, and from our own experience.
The industry sources include major industry financing companies, credit bureaus, secondary financing companies and other financial entities.
Many fleets who finance equipment may not be as strict as these industry guidelines, as they can better manage their risks through settlement deductions and a quicker / closer assessment of problems before they get too serious.
FINANCING AND PERSONALITIES
In a typical over-the-road operation, equipment with financing represents the third largest cost in your business behind payroll and fuel. It is the largest fixed cost. It usually is a tradeoff of risk versus cost (interest rate).
Financing plays a critical role for all business people, but is not usually thought about until we need it. Most people dread the financial process of borrowing money, and truckers are no exception. It is important to know what makes lenders nervous and comfortable and how we can minimize the risk and cost.
It is important to note that personality types represent a group of people as a whole. People like to be around others like themselves as noted on our “Success Test Page – Question 5.”
Personality differences between a truck operator and lender can be seen as one who is always on the move versus a one of routine work and home life. Clothes worn, personal interests and activities even further differentiate the contrast.
Lenders are generally analytical people and are on average more conservative, like an investor or a banker. When you put your own money in a bank, you want it to be safe.
Likewise, lenders want to loan out money, get it back with interest and not to hear about any business or personal problems. What they definitely don’t want is to get a piece of equipment back. Many will not lend to the trucking segment because they don’t understand it, or don’t like things that they can’t easily see.
LOAN ASSESSMENT CRITERIA
When a financing company looks at you and your business, they assess three different things. They include the structure of the loan, your credit background and your personal background.
Minimizing the financing companies risk surrounding these issues will minimize your interest rate and speed loan processing. We will review each of these in the following.
1.) THE LOAN STRUCTURE
The structure of the loan involves how much money is borrowed, how the equipment is used and the type of equipment you operate. While many lease programs ask for the first and last payments up front, the standard for conventional financing is 10%+ down for the best rates.
Equipment usage means it is used “full-time” like a typical over-the-road operator versus “seasonally” such as a logger. A lender is looking for consistency, so full-time operators generally get better consideration and therefore lower interest rates.
When it comes to the actual equipment, the specs and age do make a difference. A good way to look at it is that the lender is gambling on getting the equipment back. If they do, they want to move it easily. With newer, fancier and better speced (engine, transmission, etc.) equipment, the odds are in your favor for better rates.
2.) YOUR CREDIT BACKGROUND
This is also made up of three different issues. The first thing that is looked at in a loan assessment is your credit rating. Then they look at your experience of similar equipment paid off and for a verification of your haul income.
While these are self-explanatory, the keys are successful, verifiable consistency. If this is your first truck, an installment loan for an automobile, boat or another large item is often a good substitute.
Regarding your credit rating, the industry financing companies will request your rating first before approval. Once the loan is in place, they will report back both their positive and negative experience. Some fleets who finance equipment and secondary finance companies may do neither, which is something to assess.
Basically financiers are looking for a positive experience, such as: no slow payment history, unsatisfied liens, suits, judgments, unresolved litigation, bankruptcy, etc.
Many ask how their “Credit Rating” is assessed and YES there is a number scoring system. We have listed the categories and grading guidelines used in the point system in the following. Most use the same system for homes, automobiles, boats, etc. and so should you. The rule of thumb is “The higher the score – the better the interest rate.”
While it is hard to figure out your actual score, we suggest using the criteria in each rating in your daily financial dealings. NOTE: These are general industry norms. Some lenders will be more strict, very few will be more lenient.
CREDIT SCORE CATEGORIES
Past Payment History (Approx. 35%) ? How you?ve paid your credit bills in the past, if paid on time, items in collection and number / length of time of ?adverse public records? (bankruptcy, attachments, liens, etc.).
Amount of Credit Owed (Approx. 30%) ? How many accounts, what kind of accounts and how close you are to the credit limits.
Length of Time Credit Established (Approx. 15%) ? How long you have had specific credit accounts.
New Credit (Approx. 10%) ? Number and proportion of recently opened accounts, number of credit inquiries and the reestablishment of positive credit history after payment problems.
Types of Credit Established (Approx. 10%) ? The number and activity of various types of credit accounts including credit cards, retail store accounts, installment loans and mortgages.
- A+ to A- (Best Rating) 620 to 800′s credit score
– No late payments on mortgage or rent within last 24 months
– Only one 30-day late on installment or revolving (credit card) credit
– No bankruptcy in last seven years
– No outstanding judgments or collections
– Income & employment must be stable
– Can get up to 100% financing at best market rates
- B+ to B- (Good Credit History) 581 to 619 credit score
– One to three late payments on mortgage or rent within last 24 months
– Two to four 30-day lates are allowed on installment or revolving credit
– One to two 60-day lates in minor credit accounts (department store account)
– Bankruptcy discharged two to four years ago
– Income & employment must be stable
– Interest rate will be 1-2% higher with 5-10% down
- C to D- (Fair Credit History) 551 to 580 credit score
– Three to four 30-day late & one 60-day late payments on mortgage or rent
– Four to six 30-day lates or two to four 60-day lates on installment or revolving credit
– Bankruptcy discharged from one to two years ago
– Income & employment must be stable
– Interest rate will be 2-4% higher with 10-20% down
- D to D- (Poor Credit History) 550 and below
– Two to six 30-day lates with 60, 90 & 120 day lates possible on mortgage or rent within last 24 months
– Poor payment past with continuing pattern of lates on installment or revolving credit
– Recent bankruptcy with unpaid judgments or tax liens to be paid off
– Income & employment must be stable
– Interest rate will be 5-8% (or more) higher with 20-30% down
To contact the major credit bureaus, call:
Trans Union: 800-916-8800
Credit Report Management System: www.FixMyCR.com
3.) YOUR PERSONAL BACKGROUND
Since your loan is to be paid back over time, financing companies like to see signs of personal stability. This includes good work history, experience as a business operator, stable residential history and a good marriage.
In general terms, most industry financiers look at how long you have worked at your current employer, or how long you have been in business. The rule is “The more the better.” The general rule for time as an independent contractor / operation is 3+ years verified.
The general rules for residential history is 3+ years as a homeowner or 5+ years as a tenant.
Again, you can imagine how each of these personal issues makes financiers more comfortable. Addressing these concerns will also minimize your risk to them.
OTHER PLANNING CONSIDERATIONS
If you really want to blow the financing community away, present them with a business plan (see “Writing Your Plan” page). If a financier suspects that you don’t understand the industry or have a basic understanding of business, you may pass the numbers part but not get the loan or the best rates.
Preparing a basic financial plan (similar to that on “Net Profitability” page), allows them to view your assessment of profitability and affordability. The income / expense summary shows your focus and spending projections.
Having, costing out and understanding a fleet / shipper contract is another piece you can use to help minimize risk. Ensuring that these issues are covered, along with the appropriate insurance and maintenance / repair issues, rounds out the package.
Another helpful assessment is a balance sheet. One with a positive net worth indicates your general economic well being. It also shows what you are really worth, allows for a reduced risk factor to the lender, and subsequently a lower interest rate.
CONVENTIONAL VERSUS LEASE (RENTAL, TRAC & LEASE-PURCHASE) FINANCING
Did you know that businesses lease or lease-purchase over three quarters (3/4) of their equipment today? The most common transportation modes doing this are airlines and railroads, but many also do it in trucking.
Many people have mixed feelings about lease financing due to past experience or stories regarding fleet lease programs, but there are many pluses not well explained. Additionally, there are different types of leases that we will briefly cover, but will spend more time on what many believe is the best type for the small or owner-operator.
There are three basic types of leases. They include Lease-Rental, TRAC-Leases and Lease-Purchase.
The Lease-Rentals have a set daily / monthly / longer term price, plus mileage charges. A number of services come with it, but there is no residual equipment value to the user. The best ways to think of these are trucks used by some fleet independent contractor lease programs, major corporate businesses and rental trucks. One simply turns the equipment back when their contract ends.
TRAC-Lease means ?Terminal Residual Adjustment Clause? in tax terms. The user and financier agree on a monthly payment / residual value. At the end of the lease, the user can either pay the residual, own the equipment and do whatever they want with it or otherwise turn it in. If the value of the equipment is greater than the residual, they can cash it out or use it as a down payment on another truck. If the value of the equipment is less than the residual value, the operator must make up the difference. The operator is responsible for all operating, maintenance and repair issues and costs.
A Lease-Purchase is similar to a TRAC-Lease, without the residual adjustment clause. In other words, if the market value of the equipment is less than the residual value, there is no penalty. All else is basically the same. One can see there is more risk to the operator in a TRAC-Lease than a Lease-Purchase, especially critical for the small operator and independent contractor.
We have summarized many additional reasons to consider lease-purchase financing in the following. It depends on a number of circumstances and variables, some of which you can control and others not. A primary goal of any business is to minimize risk, and this will help think through one of your largest.
CONVENTIONAL FINANCING COMPARISON DETAIL
The fundamental difference between conventional and lease financing is that at the end of the term, you will not own the vehicle unless you exercise the purchase option. To exercise the purchase option you will pay an additional amount at the end of the lease, which is called the residual value.
By law, the residual value, or method for calculating it, must be disclosed in the financing agreement. It may be more or less than the vehicle is worth, depending in part on current truck (resale) values. It also depends on many other issues (new, used, trade, term, etc.). It can be targeted to fair market value, but can be as low as $1. If you do not want the vehicle, you will not be required to buy it, but just turn it in according to the terms of the lease (which could be good with recent depressed truck values).
If, however, you decide to exercise the purchase option, the finance company can normally finance that amount over a shorter term or roll it into a down payment on another truck. You can also independently finance it. In most cases when lease financing, one can more easily and frequently add or update to newer equipment.
Other advantages of lease-purchase include lower down payments, usually one payment (2-4%), and lower monthly payments. This contrasts with the industry average of 10-20% down for conventional financing with potentially higher monthly payments, depending on your financial health.
First year tax advantages may be better for conventional financing, due to accelerated depreciation, but there may be capital gains liabilities as a result. There are other tax advantages to a lease-purchase (e.g. no sales tax paid to Title State after purchase – it’s included in contract). You should discuss all of the tax consequences as they apply to you with your tax advisor.
Whether using conventional and lease-purchase financing, anytime you buy a vehicle (truck or car), it typically starts to lose value the minute you drive it off the lot. As a general rule, it is difficult to trade a truck (or a car for that matter) if you have not made the majority of your payments.
With conventional financing, you are building equity in the vehicle by paying down the principal. In many conventional contracts, you pay more interest per payment in the early years and more principal per payment in the latter (Rule of 78). If you try to trade in the early stages of your finance contract there is a high probability that you will not have enough equity in your truck to make it a favorable deal for you.
A lease-purchase may be easier and less costly to deal with than conventional financing, which is advantageous to independent contractors. If you wish to trade early or return equipment, it can be resold internally and not taken to auction ? i.e. with you required to make up the larger deficit.
Most major industry financiers offer conventional financing, Lease-Rentals, TRAC-Leases and lease-purchase, but push you toward conventional financing or TRAC-Leases due to the risk (more on you). Over the full term of a lease or purchase, the cash flow for payments, expenses and tax deductions will be close to the same. With conventional financing you deduct interest plus depreciation (potential capital gains). With all lease products you deduct the total payment.
The largest advantages to a lease-purchase is no sales tax paid after purchase (it’s included in purchase), minimizing risk on equipment values (not necessarily on TRAC-Leases), the equipment doesn?t show up on your balance sheet (making other borrowing easier) and the flexibility of the transaction.
Feel free to give us a call with any questions you may have regarding this or any other issue we may be able to help with.
Many view truckers like the cowboys of the past. This is one of those mindset issues that we felt we couldn’t overlook. There is a view from numerous people including those in finance, that there is a mystique about truck operators.
It is as we mentioned before, the clothes worn, the lifestyle and the types of activities enjoyed. Then there is the issue of the open road, different scenery, different people and riding off into the sunset…
You may call it fiction, they may call it romantic, others may call it jealousy, but the bottom line is that you are different and you should be prepared to deal with others on their terms. In other words, successful business people are able to deal with many levels and different kinds of people on an on-going basis.
Your bottom line is to be successful in the future. The interest rate is the tool used by the financing community to make the risk worthwhile. The bigger the risk, the higher the interest rate.
You must develop value-added business associations similar to ones you have in your other affairs. The best place for money is still from a source from which you can develop a long-term personal relationship.