Types of Equipment Leases
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One of the most popular reasons businesses use equipment leasing is flexibility. Leases provide some of the most diverse options for equipment financing thanks to the variety of leases available. Understanding what separates these forms of leases is essential if you want to utilize the full extent of flexibility that leases provide.
In the context of equipment leases, there are two primary categories: capital and operating. Most common types of equipment leases will fall under either of these two categories.
A capital lease is more akin to a loan than an operating lease because, in a capital lease, the lessee is registered as the owner and is typically expected to buy the equipment for a nominal fee at the end of the lease. To qualify as a capital lease, a lease contract must meet at least one of the following criteria:
- The length of the lease must be 75% or more of the asset’s useful life (the estimated lifespan of the asset based on calculated depreciation).
- The lease contains a buyout price that is less than the market value of the asset.
- The total value (AKA present value) of the minimum payments on the lease must be greater than 90% of the asset’s market value.
- The lessee must gain ownership of the equipment either through a buyout or as part of the lease.
Capital leases typically work best for those who are certain that they want to keep their equipment after the lease is up and gain the benefits of ownership (most often for tax purposes) throughout the duration of the lease.
Types of Capital Leases
$1 Buyout Leases
A $1 buyout lease is exactly what it sounds like. The lessee makes monthly payments that will cover most of the initial cost of the equipment over the course of the entire lease with the expectation that they purchase the equipment for $1 at the end of the lease.
- Virtually the same as an equipment loan or EFA.
- Some of these will leave the $1 buyout optional.
- Useful for those who don’t want the potential down-payment of a loan.
Purchase Upon Termination (PUT) Leases
Simply PUT (okay that’s the only pun, I promise) PUT leases are capital leases that include a mandatory buyout at an agreed upon price once the lease is up. Usually, the buyout is set at 10% of the initial market value.
- Lower monthly payments compared to other leases because the buyout is guaranteed.
- Best for equipment that may appreciate.
Operating leases are more in tune with what most people have in mind when they think of leases. In an operating lease, the lessee is not the registered owner of the equipment, there is no buyout option, and the lessee or lessor decides the length of the lease. Think of them almost like more structured rental agreements.
Operating leases are beneficial for equipment that’s at risk of becoming obsolete over the lifetime of the lease or equipment that the lessee expects to upgrade quickly.
Types of Operating Leases
Fair Market Value (FMV) Leases
An FMV lease will provide the option to renew the lease, return the equipment, or purchase the equipment at its fair market value (hence the name) at the end of the lease. The fair market value is based on the market price of the equipment at the end of the lease.
- These will typically offer the smallest monthly payment options out of most leases.
- Useful for those looking for flexibility and low monthly payments.
A leaseback lease is perhaps the most unique leasing option available. With a leaseback, the original equipment owner sells their equipment to another business (typically another lender) who then leases it back to the original owner. The main benefit being that you can continue to use this equipment to earn revenue while earning capital from the original sale.
- These usually provide a buyout option.
- Best for businesses that want to earn revenue quickly.
Leases That can be Both
Terminal Rental Adjustment Clause (TRAC) Leases
TRAC leases can be a capital or operating lease and are only available for vehicles. Because the market for vehicles is so volatile, these leases tend to be much more flexible than most by allowing the payments to be adjustable depending on price fluctuations.
- These will usually have a buyout option at the end of the lease.
- The rates and buyout price of traditional TRAC leases are typically more negotiable compared to other leases.