Equipment Leasing vs Financing: Which is Best for You?
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Generally, the difference between equipment leasing and equipment financing are minimal. Leases tend to be reserved for short term agreements, while financing is more long term.
However, few things are straightforward when it comes to finances and equipment leases and financing are no exceptions. This article is designed to give you a crash course on everything you need to know before setting out to find monthly payment options for your equipment and help you maximize the benefits of whichever option you choose.
Most equipment leases are essentially a structured rental agreement. When you lease a piece of equipment, you’re paying for the cost to rent it rather than working towards purchasing it outright; however, that’s not always the case. Some leases are structured more like a loan and many provide a variety of options for the lessee (the person who signs the lease) to purchase the equipment once the lease is up. The wide assortment of leases available make leasing a more flexible option than financing.
There are two main types of equipment leases that you’re likely to encounter in your search:
Capital leases are structured similarly to loans in that the lessee lists the equipment as a company asset (often for tax benefits) and the lease has an agreed upon buyout price at the end of the lease. These are great for companies that want to own equipment after the lease is up but don’t want to deal with the down payments or longer terms that are associated with financing.
- An agreed upon nominal buyout price (usually from 10% full equipment price to $1) at the end of the lease.
- Equipment is registered as lessee’s asset.
- Lessee can only list interest on payments as an expense on tax returns.
Operating leases are what the average person likely thinks of when they think of leases – something I’m sure everyone loves to do. The lessee makes payments for the cost of operating the equipment (hence the name) rather than making payments towards purchasing the equipment. Equipment under these leases aren’t registered as an asset for the lessee. These fit best for businesses who only want the equipment for a short term such as tech companies or businesses in a rapidly advancing industry.
- Option to renew lease, purchase equipment, or return equipment at end of lease.
- Lessee is not registered as equipment owner.
- Payments can be registered as operating expenses.
There are also categories of capital or operating leases that are tailored to more specific scenarios such as leasebacks or TRAC leases.
Pros of Leasing:
- Better tax breaks than a loan (on average)
- Good for equipment that depreciates in value
- No down payment
- Simple application
Cons of Leasing:
- Not always a smart long-term investment
- Harder to qualify for than a loan
- Restrictive contracts on how equipment can be used
- You don’t own your equipment (if you’re using an operating lease)
Equipment loans (AKA equipment financing) are relatively straightforward when compared to equipment leases. When you take on an equipment loan, you’re borrowing the capital to purchase the equipment outright and pay off the initial cost, plus interest through regular payments. You’re on the hook for whatever equipment you finance as it’s registered as your business’ asset.
Before signing a loan agreement, you should take a close look at the offered rates, term lengths, and down payment as those can vary widely across different lenders. With the right loan, equipment financing will often cost less than a lease thanks to tax breaks and better rates.
As with leases, you’re likely to come across two types of equipment loans when working with a bank or financing company:
Equipment Finance Agreement (EFA)
On a balance sheet, an EFA will look very similar to a capital lease in that the interest rates are baked into your monthly payments rather than applied on top of them. This means that you won’t be able to make payments towards your principal (the original cost of the equipment) or interest. Instead, you’ll be making consistent payments on a set term.
The main benefits of an EFA are that they’re likely to be more flexible than a simple interest loan. For example, many businesses with fluctuating cash flow (such as seasonal businesses) are more likely to use an EFA because they’re more likely to include clauses that lower or delay payments during the off-season.
Simple interest loan
A simple interest loan works like your standard loan because it has a separate principal and interest rate. As a result, the monthly payments can fluctuate as the interest rate increases and decreases. Depending on the fine print within your loan agreement, you may be able to specify whether you’re paying towards your interest or principal which leaves the door open for an earlier buy off.
Ultimately, the potential benefits from taking out a simple interest loan for equipment will vary from lender to lender. However, if terms are good, then the benefits could outweigh some of the risks.
Pros of Financing:
- Easier qualification
- No collateral
- Low cost long term
Cons of Financing:
- Down payment could be required
- Long term commitment
How to Choose
Now that you understand the basics of leases and loans, it’s time to put that knowledge to work.
While there are no catch-all answers when it comes to choosing between a lease or a loan for your equipment, there are a few general guidelines to consider.
If you want to keep the equipment for a long time and have the funds available for a down payment, financing is likely the better choice for you.
If you’re more interested in a short-term investment and want to keep your options flexible, you’d likely be better off leasing the equipment instead.
And if this guide is leaving you with even more questions, you can always contact one of our experts for a free consultation.