Equipment is costly to purchase and maintain, and new models are released often. There are benefits to leasing equipment that come with not owning it, such as the opportunity to upgrade to the newest models as they become available and monthly rental payments.
Leasing might be a possibility to take into consideration if your company needs new technology or equipment but is unable to pay for it completely. But leasing can end up costing more in the long term; therefore, many firms find it difficult to make this choice. This guide outlines the terms of equipment leasing as well as factors to take into account when choosing whether to buy or lease equipment for your company.
What is leasing equipment?
A sort of financing called equipment leasing allows you to rent equipment rather than buy it completely. For your company, you can lease pricey equipment like computers, cars, and machines. The equipment is leased for a predetermined amount of time; at that point, you have the option to buy the equipment, return it, or extend the lease.
Equipment financing is borrowing money for a commercial purpose and using the equipment as security to pay back the loan over a certain period of time. This is not the same as leasing equipment. If so, after you pay off the loan, you become the owner of the equipment.
When you have an equipment lease, after the leasing time is up, the equipment is not yours to keep. Leasing equipment entails paying interest and fees, which are typically included in the monthly payment, just like with a company loan. Additional costs can apply for repairs, maintenance, and insurance.
Although leasing equipment might be far more expensive over time than buying it outright, it can provide small business owners with limited funds with a rapid way to obtain the equipment they need.
How does a lease for equipment operate?
You sign a lease agreement with the equipment owner or vendor if you choose to lease rather than buy equipment for your company. The equipment owner prepares an agreement that specifies the length of the lease and the monthly payment amount, much like a rental lease agreement.
You are allowed to use the equipment until the end of the lease period. Many leases cannot be canceled; however, there are several circumstances in which you can break the agreement. These circumstances should be included in the contract. Depending on the provider, you can frequently buy the equipment at the going rate once the lease expires.
The cost to lease the equipment varies depending on the leasing firm. The charges you are charged also depend on your business credit score. The cost of leasing equipment will increase with your level of risk as a lender. It only takes a few minutes to approve an equipment lease online. It’s crucial to conduct research to identify the best financing solution for your company because leasing businesses frequently focus on particular industries.
Depending on the kind of equipment, equipment lease lengths can be three, seven, or ten years.
Since equipment leasing is not a loan, it won’t affect your credit score or interfere with your capacity to obtain loans. If you use the equipment for your business, the IRS often allows you to deduct your equipment leasing payments.
Advantages of Leasing Equipment
Cash-strapped small enterprises might profit greatly from equipment leasing. Here are some benefits of leasing your equipment, even if there are several ways to finance a lease and not all leases are the same:
- It is affordable to begin with. Not many lessors demand a sizable down payment.
- You can upgrade your gear. Leasing is a fantastic alternative if you frequently need to update equipment because it allows you to avoid being stuck with outdated machinery.
- It’s simpler to climb. You can upgrade to more sophisticated machinery to manage a larger volume of work without having to sell your current equipment and look for replacements.
- It might provide tax credits. Tax credits are frequently available for equipment leases. Utilizing Section 179 qualifying financing deductions, you might be able to write off your payments as a business expenditure, depending on the terms of the lease.
How to begin renting out equipment
Provide your answers to the following questions before beginning the equipment lease procedure. Even though it might seem like a lot of work up front, you won’t be able to decide whether to buy or lease equipment if you don’t have the answers to these crucial business-related questions.
What is the amount you set aside each month?
Even though leasing has far smaller monthly payments than buying, you still need to account for the charges in your monthly cash flow. Instead of working the other way around by obtaining price quotations and attempting to fit them into your budget, start with what you can afford and go from there.
How long are you going to use the tools?
The most economical option is virtually always to lease equipment for short-term use. A conventional line of credit or loan can be more advantageous if you plan to use the equipment for three years or longer. Take into account the expansion of your company as well. If it is expanding quickly, leasing can be a better option than purchasing.
How soon will the machinery age out of use?
Certain industries have a faster rate of technological obsolescence than others. When determining whether to buy or lease, take obsolescence into account.
Can I rent the equipment?
The list of equipment that is eligible for a lease is nearly infinite. However, there are a few requirements.
- Purchase price: Leasing equipment allows your company to acquire expensive machinery and equipment. This covers pricey individual products like heart monitors and extraction equipment as well as more affordable, larger-scale commodities like software licenses, phones, and kiosks. Because of this, it’s unusual to find a lease agreement for purchases under $3,000, and a minimum purchase amount of $25,000 to $50,000 is required by many large lenders.
- Hard assets: Any equipment that isn’t permanently fixed to real estate and can be described as personal property qualifies as a hard asset, which includes the equipment you lease. Lease programs do not apply to soft assets like warranties and staff training programs.
Buying versus leasing
While leasing equipment offers many benefits for businesses, there are situations where buying it outright is more economical. Take into account the following aspects when comparing leasing and buying options:
- Purchase cost
- The amount that needs to be funded
- Depreciation per year
- Inflation and tax rates
- Costs of leasing each month
- Use of equipment
- Costs of ownership and upkeep
Pros and cons of renting equipment
For equipment that needs to be upgraded frequently, like computers and other electronic gadgets, a lease is the best option. With a set rate and no up-front costs, leasing allows you to afford the newest equipment while having manageable monthly payments.
Additionally, leasing gives companies access to a greater variety of equipment choices. You can now afford equipment that would otherwise be too expensive to buy, thanks to leasing.
However, there are several disadvantages. Interest payments are a requirement of leasing, which gradually raises the machine’s total cost. Leasing can occasionally be more expensive than buying the equipment altogether, particularly if you decide to buy it after the lease has ended.
Some lenders also impose required service packages and a minimum term length. If the lease period is longer than the amount of time you require for the equipment, this could increase the total cost. In this case, you can be forced to pay a monthly payment and incur storage expenses for equipment that isn’t being used.
Benefits and drawbacks of purchasing gear
Owning a piece of equipment allows you to customize it to meet your specific requirements. With a lease, this isn’t always the case. In a similar vein, restrictions imposed by an equipment lessor are not binding on buyers.
Buying something also lets you take care of problems faster because you don’t need permission from the leasing company to arrange for maintenance or place an order for a replacement item. When you sell the equipment when you’re done using it, you can make some money in addition to the depreciation tax savings provided by Section 179.
Just like renting, buying has disadvantages. The largest is obsolescence; once you make a purchase, you’re stuck using antiquated gear until you make a new purchase. Additionally, the availability of tax savings with leasing and the competitiveness of the market frequently deter many business owners from buying equipment outright. Your business can be financially strained by the high purchase price of machinery as well as the expenditures on maintenance and repairs.
According to some estimates, companies set aside between 1 and 3 percent of sales for maintenance. However, this is only a preliminary estimate. The equipment’s quality, warranty, age, and number of service hours determine the actual maintenance costs.
Comparing different financing options with equipment leasing
Leasing isn’t the only option available besides buying. It’s not even the most typical, in actuality. Some of the best business loans might be able to meet your small company’s equipment needs. Another well-liked method of financing equipment purchases is through lines of credit and factoring services.
Business loans give you greater ownership of the equipment, just like a purchase would. After you lease equipment, the lessor owns the title to it and gives you the choice to purchase it after the lease expires. By using a loan to secure the purchase against current assets, you can keep the title to any goods you buy.
Regrettably, terms may be a significant disadvantage of a loan. A loan or line of credit’s interest rate may change over the course of the loan, in contrast to leases’ fixed-rate financing. Budgeting may become difficult as a result, contingent on the loan amount. Moreover, banks and other lenders frequently demand a substantially higher down payment—roughly 20% of the equipment’s overall cost, according to some estimates.
Another option for buying expensive equipment is to factor, which is frequently quicker than loan applications. You can swiftly convert unpaid invoices into cash by selling them to a factor and leveraging your accounts receivable. Depending on your clients’ creditworthiness, factoring can pay up to 90% of the total value of your accounts receivable, making it a great alternative to leasing and loans for startups and small enterprises.
Usually, funding is made accessible within a few days. This makes factoring a well-liked resource for companies that frequently handle contracts with a short turnaround time, the transportation sector, and smaller industrial enterprises.
Leasing Procedure: What to Anticipate
The following steps are often involved in the lease application process:
- You fill out an application for leasing equipment. Make sure you have your company’s and its principals’ financial information on hand, as this may be needed either before or after you submit the application.
- After processing your application, the lessor notifies you of the outcome. Usually, this takes place 24 to 48 hours after the application is submitted. Financial statements and a business plan might not be necessary for certain lessors when applying for loans between $10,000 and $100,000. Expect to produce comprehensive financials and a business plan for loans over $100,000.
- After approval, you have to check and complete the leasing arrangement, which includes the fixed APR and monthly payments. After that, you’ll sign the paperwork again and send it back to the lessor, usually with the initial payment.
- You are informed that the lease is in force and that you are free to accept delivery of the equipment and start any required training as soon as the lessor has received and acknowledged the signed documentation and first payment.
Types of equipment leasing: operating and financing
Operating and financial leases are the two main categories of equipment leases. Below is an explanation of each.
An operating lease: what is it?
An operating lease gives a business the temporary, ownership-free use of an asset for a predetermined amount of time. Typically, the lease term is less than the equipment’s useful life. The lessor may be able to recover additional expenses through selling at the end of the lease.
Equipment leased under an operating lease is not eligible to be designated as capital, unlike equipment purchased outright or financed by a conventional loan. It is recorded as the cost of renting. This offers the following two distinct financial benefits:
- Equipment is not listed as a liability or an asset.
- Tax incentives are still applicable to equipment.
Although dealer rates might differ significantly, operating leases typically have an annual percentage rate (APR) of 5% or less. Contracts typically run from 12 to 36 months.
Because leasing is so common, the Financial Accounting Standards Board’s 2016 accounting rules mandate that businesses disclose their lease commitments in order to prevent giving the misleading impression of being financially strong.
Actually, balance sheets now have to reflect all equipment leases except the short-term ones. Under an operational lease, leased equipment is exempt from reporting requirements as an asset, but it is still subject to several obligations.
A financing lease: what is it?
A finance lease arrangement, often referred to as a capital lease, is comparable to an operational lease in that the lessor is the owner of the equipment that is leased. The lease itself is recorded as an asset, which raises the holdings and liabilities of your business. This is where it differs.
Large businesses frequently employ this arrangement, which has a special benefit in that it enables the company to claim both the interest expenditure related to the lease and the depreciation tax credit on the equipment. Examples of these businesses include major stores and airlines. Furthermore, after a financing lease expires, the business has the option to buy the equipment.
The APR for a finance lease is greater because of the financial advantage it offers. Currently, standard interest rates range from 6 to 9 percent, with contracts lasting anywhere from 24 to 72 months.
There may be costs associated with extra duties that go above and beyond your monthly leasing payment. Usually, these consist of the following:
- Liability insurance: Many organizations report paying $1,000 or less for liability insurance, with average estimates for coverage ranging from $200 to $2,200 a year.
- Unexpected expenses: The terms of your lease may require you to pay for certain upkeep and repairs. Any legal fees, penalties, and certification costs are examples of unnecessary expenses.
- Shipping fees: This covers the cost of return shipping for the equipment as well as transportation.
- Additional costs: Carefully review your contract. One-time documentation fees, which can cost up to $250, and late payment fees, which range from $25 to 15% of the amount past due, are additional costs that may be incurred.
Comparing lenders that finance equipment
In light of the expenses and factors discussed, it is imperative that you compare multiple lease providers to guarantee the best possible deal. You become aware of these three categories of equipment lending companies and the advantages they offer before you start looking:
Broker for leases
A broker for leases acts as a go-between for you and potential lessors. The broker will take care of most of the paperwork for you, presenting you with the offers and submitting your financing requests.
Brokers only control a small portion of the leasing industry, and they demand a premium for their services. It is said that brokers charge between two and four percent of the equipment cost to broker a contract.
Utilizing a broker has advantages because of their wide-ranging connections. They specialize in acquiring a greater variety of equipment, occasionally at lower costs than would be available through traditional routes, and are frequently industry-specific.
A leasing firm is frequently a manufacturer’s or dealer’s subsidiary leasing arm. A leasing business’s only goal is to enable leases with its parent company or dealer network; it is often referred to as a captive lessor. Because of this, you will typically only interact with a leasing firm when collaborating directly with a manufacturer.
All third-party lease providers fall under the category of independent lessors. Banks, leasing experts, and diverse financial firms are examples of independent lessors who offer equipment leasing straight to your company. Unlike leasing firms, they usually focus on equipment remarketing, which allows them to combine products from different manufacturers and provide more attractive annual percentage rates.
Advice on selecting a lessor
The ideal guideline for selecting a quality lessor is to evaluate the business with the same rigor that you and your organization are subjected to. Give priority to people who are eager to collaborate with your company. Their level of training and expertise in your industry or their willingness to work together under particular circumstances could serve as indicators of this.
Depending on the lessor, certain payments included under the lessee’s obligations, like application and late fees (at least on the initial late payment), may be reimbursed or completely waived.
Spend some time learning important details about the lessor as well.
- Examine the lessor’s financial accounts, company ties, payment and credit histories, business summaries, and any publicly available documents for business information.
- Pending litigation: Look for any notices of pending litigation in public records.
- Is the payment method easy to use, or does it involve a ton of paperwork?
Questions to put to a dealer
Obtain quotations from three or more businesses before selecting a dealer, and make sure to ask these questions of every dealer on your list. Obtaining a fair price for the products and services your business offers requires careful questioning, which is half the fight.
- How much cash in advance is needed? Most of the time, lease finance covers all of the costs associated with buying equipment. Loans don’t; often, a down payment of up to 20% of the total amount is required. If a down payment is necessary, you may need to reallocate funds to pay for the associated upfront expenses.
- Who makes use of the tax benefits? A loan arrangement allows your business to deduct depreciation. However, the interest rate is higher, and a down payment is required. The lessor is entitled to depreciation under a lease. It provides a cheaper APR in return, frequently half that of a loan. Inquire about capital leases or financing options if you still wish to lease, but the depreciation credit is vital to you.
- Are the terms of funding negotiable? Considered the most flexible form of finance, leasing is preferred over loans in many cases. You can delay payment to give yourself an extension before the first payment is due, start with low payments and increase them over time (known as a “step-up lease”), or even add new equipment to an existing lease under a “master lease” structure. All of these options depend on the details of the lease structure.
Consider a lease-to-own option if you would like to keep the equipment you lease for your company but lack the funds to buy it outright or the credit to be approved for a conventional loan. Lease-to-own contracts mandate that companies pay back the equipment over a predetermined period of time in order to become the owners of the machinery.
There are four main elements to a lease-to-own agreement:
- The lessee, who has the option to buy the equipment at the end of the term, signs an equipment leasing agreement.
- The lessor applies a portion of each payment to the cost of purchasing the equipment.
- When the lease expires, the lessor pays the outstanding amount to take possession of the equipment.
- Payments made and the equipment are forfeited to the lessor in the event that the lessee chooses not to purchase the equipment.
It’s crucial to remember that your company will probably pay more than the fair market value for the equipment if you sign a lease-to-own agreement. On the other side, your company will fully own the equipment after all payments are paid.
Lease-to-own arrangements usually have the same duration as conventional equipment leasing contracts. A portion of your payments goes toward the equipment’s purchase price when you choose an equipment leasing option, which is the primary distinction. In most cases, the lessee has the option to seek a renewal, an extension, or the return of the equipment if the firm is unable to pay for it at the conclusion of the lease.
A lease-to-own arrangement carries some dangers, even if it can be practical for many small business owners. You forfeit the equipment and all payments if your business is unable to buy it at the conclusion of the arrangement, which can result in a significant loss of funds for a small organization. Being in constant communication with your lessor and requesting to renegotiate time spans as needed is the most crucial aspect of this kind of agreement.
For heavy gear, production equipment, or any other kind of equipment that your company would normally need to purchase with a regular loan, lease-to-own agreements work best.
Buying or leasing equipment is an important decision.
Leasing your equipment could have a number of benefits for your company, depending on your needs and financial situation. There are disadvantages, too, such as increasing expenses over time, having to pay interest, and not having control over the equipment. On the other hand, since you won’t be spending a lot of money on equipment you can’t readily replace, it can help you keep up with the latest models and save on maintenance expenses. To position your company for success, take into account each of these aspects prior to leasing or purchasing new equipment.