This article will provide a quick overview of what you need to know when deciding if equipment leasing or purchase financing is right for you. Each has its pros and cons. The goal of the article is to help you understand which financing option is best for your business, based on how the equipment will be used.
Leasing is similar to renting. As you know, with renting you don’t own is the item being rented. There also are restrictions and conditions on how you can use the rented item. It’s the same with leasing. The main difference between the two is that leasing is for equipment, buildings, and property; and renting generally is for property only.
Lease agreements vary widely. Some agreements cover all repairs during the time the equipment is leased. Others may not cover certain repairs. The lessor can include Specific coverages as an add-on at an additional cost, which increases the lease’s monthly required payment. Check the agreement on what is covered before signing any lease.
There are two common scenarios when it comes to leasing equipment.
1. Not enough capital to purchase equipment. When a business doesn’t have the capital for a down payment on equipment, much less the full purchase amount, leasing the equipment is a great option. Some leases may require a down payment, but it will be much lower than that of a loan. Also, monthly payments on a lease a far lower than those on a loan.
The trade-off is that leasing has a higher interest rate (sometimes called a factor). The business pays more in financing/interest for putting up less capital. Leases are generally unsecured. This can be great for a startup that doesn’t have many assets.
2. Equipment may be obsolete within a few years. In some industries, equipment becomes outdated fairly quickly. In other cases, periodic model upgrades are released, which significantly drops the value of previous models. If the equipment you are considering falls into either of these categories, leasing makes more sense than purchasing. This way, you aren’t left with equipment that has significantly depreciated in value within just a few years.
On the flip side of #2 is a company that only wants the latest and greatest. Short-term leases certainly fit that bill. Of course, going in and out of a lease every few years will be costly; but, if the latest equipment is a must, it is a better fiscal option than financing the equipment through a loan.
A less common scenario is that the business needs the equipment for a short period of time. A loan in this situation can be costly once fees are considered. Also, the business owner will have to sell the purchased product or trade it in at a greatly reduced price once he/she is ready to liquidate the equipment. A lease avoids those issues.
At the end of the lease, there are a few options. You can buy the equipment at market value or at a previously agreed upon value. You can start another lease with the latest equipment. Or, you can return the item, ending the lease.
- Small-to-no down payment.
- Great for equipment that may become outdated within a few years.
- Lower monthly payments than an equivalent loan.
- Can be quicker and easier to qualify for than a loan.
- Must adhere to lease terms.
- Add-on coverages can be expensive.
- Leased equipment is not an asset.
Equipment financing uses the equipment you are purchasing as collateral for the loan. This means the business does not have to put up any of its own assets to finance the purchase. A down payment is usually a requirement.
Depending on the business owner's personal credit, business revenue, and creditworthiness, the interest on equipment financing can be competitive compared to a traditional loan. It will certainly be lower than an unsecured loan or a short-term loan.
Equipment financing should be used if the equipment is expected to retain value for a number of years. If model updates are rare and older equipment has a good resale value, equipment financing can be the better option than leasing.
- Equipment becomes an asset.
- As the loan is paid down, equity builds.
- Can depreciate up to $1 million of assets under IRS Code 179.Fewer conditions of use since you own the asset.
- Once the equipment is paid off, it is yours.
- Larger down payment and monthly payments vs. that of a lease.
- If a new model out of the equipment becomes available, the value of purchased equipment can drop significantly.
- Can be more difficult to qualify for than a lease.
As you can see, the decision to lease or finance equipment isn’t strictly financial. It very much depends on the scenario under which the equipment will be used and the potential for the equipment to become outdated.
Another scenario for consideration is if the business is about to be sold. The buyer may not want more assets that have loans on them. In that case, a lease that will end soon could be a better option.