Equipment leasing vs. financing
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Your business’s ability to access equipment is crucial for its development and growth. Unfortunately, most equipment is expensive — especially if your business is new or has limited access to capital. Equipment like office supplies, tractors, semi-trucks and large machinery may be out of reach if you have a limited budget.
Equipment leasing and financing exist to fill the gap, as you can get the equipment your business needs without spending thousands upfront.
Equipment leasing vs. financing
Both leasing and financing give your business access to the equipment it needs to function. A lease works as a rental agreement and generally has a lower month-to-month cost.
Financing is a type of business loan that typically costs more each month but may result in paying less overall. This is because you own the equipment outright once the loan is paid off. Depending on the type of lease you sign, your business may lose access to the equipment you need and any residual value that equipment may still have.
Both are valid options for business owners. Just keep in mind how you plan to use the equipment and what it will cost to keep and maintain it each month.
What is equipment leasing?
Equipment leasing gives you access to much-needed equipment without the higher monthly cost associated with a loan. In many cases, your business can also avoid a down payment, saving you thousands.
It is a common choice for businesses that don’t have the capital to purchase a piece of equipment outright or afford a down payment. Depending on the type of lease, you will either rent and return the equipment or purchase it with a balloon payment at the end of the lease period.
Either way, you will make monthly payments toward the equipment as you use it. You may be responsible for maintenance and other taxes, but overall, it is considered a less expensive option when compared to equipment financing.
Types of leases
There are two primary lease options available to businesses: capital and operating.
- Capital lease: A capital lease allows you to purchase the equipment at the end of the lease period. You pay insurance and taxes on the equipment, maintain it and can count it as a liability. At the end of the lease, you can buy the equipment. This may result in a balloon payment where you owe the remaining amount that wasn’t paid through the lease at once.
- Operating lease: An operating lease is a short-term rental agreement that functions like a consumer lease. You can cancel as needed and are generally not responsible for maintenance. But you may not be able to buy the equipment at the end of the lease period and can’t count it as a liability for tax purposes.
The type of lease you agree to will depend on the company you work with, the equipment you need and the duration of the lease itself.
For example, a capital lease may be better if a larger piece of machinery is too expensive to purchase outright but your business can afford to maintain and insure it. An operating lease is better suited for equipment that quickly becomes outdated.
Cost of equipment leasing
The cost of leasing equipment can vary widely depending on the type of equipment and lease you choose. But you will likely be responsible for a few common fees.
|Security deposit||The security deposit acts as a guarantee that you will return the equipment in good condition. Otherwise, you forfeit the deposit.|
|Insurance||Your business may be required to insure any equipment it leases. While not a direct fee, it is an expense you should keep in mind when choosing a lease.|
|Interest||Interest costs vary widely depending on the type of lease and your business and personal finances.|
|Late fees||Charged for late or missed payments.|
|Interim rent||If you take possession of the equipment before the start of the lease billing period, you may have to pay a prorated amount for the duration of that period.|
|Taxes||You may be responsible for paying taxes on the equipment if you choose a capital lease.|
Pros and cons of equipment leasing
|Typically no down payment||Balloon payment to buy out a capital lease|
|Ability to stay up to date on the latest industry tech||Lose residual value and equity of equipment|
|More affordable monthly payments||Unable to write depreciation off on taxes|
What is equipment financing?
Equipment financing, also known as equipment loans, is the process of borrowing money to pay for a piece of equipment or machinery. They are especially handy for equipment your business will need for years to come. If it is unlikely to become obsolete or unrepairable, a loan allows you to own the equipment outright. Once you do, you can use or sell it.
After you receive the funds, manage your equipment loan wisely. Late payments can cause fees to rack up and could potentially impact your credit. Since the monthly payment on an equipment loan is generally higher than on a lease, you may need to carefully control your cash flow to make your payments in full.
Where to get an equipment loan
You can find equipment loans through various sources, including banks and alternative lenders. Equipment loans may also be available directly through the seller, though it depends on the type of equipment you are purchasing and the size of the seller.
Some of the best equipment business loans are alternative lenders because of their speed and minimal requirements. For instance, Funding Circle has a low revenue requirement for business owners, and many other top lenders only require a minimum personal credit score of 600.
Banks also offer equipment loans, but you may need to meet more strict criteria to qualify. But the rates they offer may be more competitive because of this. Established businesses with good monthly and annual revenue should look into these and SBA loans to get the best terms.
Cost of equipment financing
Like most business loans, several common fees are associated with financing equipment.
|Down payment||While not a fee, you may be expected to make a down payment on the equipment. This can be anywhere from 10 percent to 20 percent of the total equipment value.|
|Origination fee||An origination fee is the general cost of borrowing a loan. Though the exact amount depends on the lender, some charge fees up to 5 percent of the total loan amount.|
|Appraisal fee||For large pieces of equipment that need an in-person appraisal, a lender may require you to pay an appraisal fee to secure the loan.|
|Late payment fee||Charged for late or missed payments.|
|Non-sufficient funds fee||Charged when there is not enough money to cover the monthly payment cost.|
|Prepayment penalty||Charged for early payments or earlier payoff to recoup lost interest on a loan.|
Pros and cons of equipment financing
|Own equipment at the end of loan||Higher monthly cost|
|Ability to sell the asset||Down payment required|
|Deduct loan payments and depreciation from taxes||Risk of outdated or obsolete equipment|
Requirements for equipment leasing and financing
Leasing and financing equipment have similar requirements. These include:
- At least two years in business
- Personal credit score in the good to excellent range
- Annual revenue of $50,000 or more
To lease a piece of equipment, you may also need to meet a minimum amount — some equipment is too inexpensive to lease. Other qualifications vary, and many lenders will require you to exceed the minimum to score the lowest rates on the best loan or lease.
The bottom line
Both leasing and financing equipment are useful ways to get your business the equipment it needs. Leasing is one of the top alternatives to equipment loans because it has a generally lower monthly cost. But you lose out on any equity the equipment may have.
Ultimately, the right choice will depend on your business and the type of equipment you plan to use. Long-lasting machinery may be better funded with a loan, while a lease may be better for tech that sees frequent updates. Consider overall cost and end-of-loan or end-of-lease scenarios when making your decision.
Frequently asked questions
Leasing is similar to a rental contract, where you only use the equipment for the duration of the lease. Financing involves taking out a loan — in this case, secured by the equipment — and paying it back for five to 10 years. Once the repayment is complete, your business owns the equipment outright.
It depends on the type of equipment your business needs and the speed your industry changes. Some types of equipment, like tractors or large machinery, are durable. They may last decades if properly maintained, so financing is worthwhile for many businesses. Office technology like a fax machine or copier may be better to lease since the technology advances quickly, making older machines obsolete.
While you can certainly purchase your equipment at the end of a capital lease, you may have to make a large balloon payment — which can strain your business or require a separate business loan. If you opt for an operating lease, you will lose access to your equipment and any residual value since the equipment must be returned to the lessor.