Business Loans

Guide to Equipment Leasing and Financing

Feb 11, 2022 • 10+ min read
equipment leasing vs. equipment financing
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      Should you lease new equipment or buy new equipment? That’s an essential question for almost any business, particularly in the construction industry.

      One of the ways construction firms can gain a significant advantage over competitors is by using heavy equipment and machinery that allows the business to either do more, work faster, or even add a service or specialty. However, acquiring the necessary equipment requires a significant cash outflow, which the company may not already have.

      Instead of using cash to buy the equipment outright, construction firms have 2 other options for acquiring equipment: equipment leasing and equipment financing. Deciding which is right for your business involves several considerations:

      • Type of equipment to be acquired
      • How often the equipment will be used
      • Maintenance and repair costs
      • Resale value of the equipment

      Here’s how to determine which is better for you. 

      Difference Between Equipment Leasing and Equipment Financing

      Equipment leasing and equipment financing are 2 major ways to acquire equipment, but they are structured differently. 

      What Is Equipment Leasing?

      Equipment leasing is a long-term rental agreement. A piece of equipment is purchased by a lender and rented to the construction business for a specific period of time. In return, the construction business pays the lender a monthly fee for the duration of the rental agreement (aka lease) and can use the equipment as if it were their own. When the lease ends, the equipment is returned to the lender, although the construction business usually has an option to renew the lease or purchase the equipment. Lease payments usually remain consistent throughout the lease term, and there is no additional interest charge, although any interest that might be associated with the lender’s cost of the equipment is factored into the monthly payment. A monthly lease payment may also be lower than an equivalent loan.

      What Is Equipment Financing?

      Equipment financing or an equipment loan, on the other hand, refers to borrowing money to purchase a piece of equipment. The financing firm can lend most if not the entire cost of the equipment. In exchange, the construction business pays a portion of the purchase price (usually each month) along with interest and other fees, depending on the terms of the loan, until the entire purchase price has been paid. At that time, the equipment was owned in full by the construction business. Monthly payments may be slightly higher for an equipment loan than for an equipment lease, but when the loan is paid off, the equipment belongs to the construction business.

      Equipment lease:Equipment loan:
      Monthly flat-fee rental costMonthly payment including a portion of the purchase price plus interest
      Monthly payment likely lower Payment likely higher than a lease payment
      Equipment owned by lender at the end of leaseEquipment owned outright by construction business after final payment made 

      Equipment Leasing Pros and Cons

      Some pieces of equipment risk becoming outdated. If you are considering using a piece of equipment that is in danger of being obsolete in the future, an equipment lease may be a better option than a loan. With this option, since you did not own the equipment, you would not shoulder that risk. In addition, lease periods are usually between 2 years and 7 years, which will usually not outlast the equipment’s useful life. 

      Equipment leasing often has a lower impact on cash flow. Leasing spreads payments out over the duration of the lease, allowing your business’ cash to be used for other opportunities like paying expenses or funding your growth. Also, the lease doesn’t attempt to reclaim the full purchase price for the equipment during the initial lease period—monthly payments are a rental or usage fee—since after the lease ends, the lender will still own the equipment.

      However, the disadvantage of choosing to lease equipment is that the equipment is still owned by the lender. Additionally, not all equipment is available for leasing: choice may become a deciding factor for some construction firms.

      Advantages of an equipment lease:Disadvantages of an equipment lease:
      Lower impact on cash flowEquipment owned by lender
      Good for short-term equipment needsPayments an expense that are not tied to the eventual ownership of the asset
      Good for equipment in danger of becoming obsoleteEquipment possibly limited

      Equipment Financing Pros and Cons

      If you are considering using a piece of equipment that you know is durable and will last a long time, your best option is equipment financing. The terms of the loan depend on the type of equipment you need, and usually, the lender will front between 80% and 100% of its entire cost. In addition, the qualification process is easier, since the equipment itself will serve as collateral. 

      One of the downsides of an equipment loan is the required initial down payment, which can be a challenge if you are having cash flow issues. Moreover, you have full ownership of the equipment, so you will assume the risk of owning obsolete equipment in the future. This risk is why it is advised only to get an equipment loan when you know the piece of equipment will last a long time. 

      The decision of whether to lease or finance your equipment acquisition depends entirely on your business situation. Before deciding which course of action to take, evaluate your business goals and choose which method aligns with your objectives.

      Advantages of an equipment loan:Disadvantages of an equipment loan:
      Construction business retains full ownership of equipmentDown payment required
      Equipment has resale valueBigger impact on cash flow
      Choice of equipment not limitedRisk of equipment being obsolete shifts to construction business

      How Equipment Leasing Works

      Often offered by equipment financing companies and other lenders, equipment leasing allows you to rent and use the equipment you need to run your business for a certain period of time. Once your lease ends, you return the equipment. Depending on the terms of your lease, you might have the option to buy the equipment at current market value or another agreed-upon price when your lease is up. 

      While terms vary and will depend on your lender and unique situation, 3-, 7-, and 10-year terms are common. Equipment leasing typically requires either no down payment or a down payment requirement of at least 5% and with no requirement to provide your own collateral. If you default on your payments, the lessor will have the right to repossess the equipment. It’s also important to know that, even though there are some exceptions, most equipment leases can’t be canceled. 

      Keep in mind also that, since equipment leasing isn’t a loan, it won’t help or hurt your credit. It may, however, let you save some money on your taxes. In general, there are 5 types of leases you can choose from, including: 

      • $1 Buyout Lease: A $1 buyout lease is a lot like an equipment loan. You make payments to rent the equipment and can purchase it for $1 at the end of the lease. If you go this route, be prepared for higher payments. 
      • 10% Option Lease: The 10% lease lets you make payments and purchase the equipment for 10% of its initial value or walk away once the lease comes to an end. Since there is a larger balloon payment, monthly payments for the 10% option lease are lower than those for the $1 buyout lease. 
      • Fair Market Value Lease: With the fair market value lease, you can make payments and use the equipment during the lease. At the end of the lease, you have the option to buy the equipment at fair market value, return it, or renew the lease.
      • 10% Purchase Upon Termination Lease: The 10% purchase upon termination lease is like the 10% option lease with one major difference: you must purchase the equipment at the end of the lease.

      Terminal Rental Adjustment Clause Lease: Typically used for semi-trucks and other vehicles, the terminal rental adjustment clause lease permits the lessee the flexibility to set a higher balloon payment at the end of the lease. For this reason, it has lower monthly payments.

      Equipment Leasing Pricing

      The rates you pay to lease equipment for your business will depend on the leasing company or lender, as well as your business credit score. Of course, the lowest rates are reserved for borrowers with the best credit scores. 

      Typical interest rates for equipment leases range from 7% to 16%. Down payments usually start at 5%, but there are many no-down payment options available. If you lease a $50,000 piece of equipment, a 12-month lease may run you between $4,000 to $5,000 per month. For a 60-month lease, you can expect to pay anywhere from $800 to $1,500 per month.

      Most equipment leasing companies offer a leasing payment calculator that can allow you to estimate your total monthly costs based on your situation. You might also be able to request a no-obligation quote. 

      Equipment Leasing vs. Equipment Financing: Which is Right for You?

      Your decision to lease construction equipment vs. finance construction equipment involves several considerations including the type of equipment you’re considering, how often you’ll use it, the cost of maintenance, the projected ROI, the resale value, and, of course, what you can afford (our equipment loan calculator can help with this). But these general rules will hold true across the board:

      • Lease: if you’re considering a piece of equipment in danger of becoming obsolete
      • Finance: If the equipment is integral and a long-term part of your operation
      • Lease: If immediate cash flow is a concern, leasing may be more affordable
      • Finance: If investment, resale, and ROI are important to you

      You may also use this guide for more information about leasing vs. financing for your construction business.

      Equipment Leasing vs. Financing FAQs

      While all leases and loans are different, leasing usually results in a lower monthly payment, because the ownership of the equipment is retained by the lender. However, in the long term, leasing can be more expensive if the equipment is needed after the lease ends. Also, the construction business can’t resell leased equipment. Buying the equipment through a loan gives the small business owner/construction business the ability to recoup loan payments by reselling the equipment. This means a positive return on the construction business’ investment.

        

      Equipment leasing and equipment financing are two ways to acquire new equipment for construction businesses. Equipment leasing means you’re “renting” the equipment, but the ownership of the equipment stays with the lender. Equipment financing means you’re paying a portion of the purchase price of the equipment monthly (plus interest), but once all payments are made, you’ll own the equipment.

       

      Whether it’s better for your construction business to lease equipment vs. finance equipment depends on your unique situation, including your long-term plans and your short-term cash flow. Leasing tends to result in lower monthly payments, but is seen solely as an expense, since the equipment is still owned by the lender. Equipment financing results in ownership of the equipment, which can then be used long-term or resold.

      Equipment leases do not have an additional interest rate. Instead, construction firms pay a set monthly fee to use the equipment for a set period of time. This fee is equal to any interest that might be associated with the lender’s cost of the equipment will be incorporated into the monthly payment. Equipment loans and financing, on the other hand, have interest rates that are determined by a number of factors. As of February 2022, the range was 6–15%, although there can be some variation.

      All leases will be structured differently, but you won’t see an “interest” line item on an equipment lease. Instead, any interest that might be associated with the lender’s cost of the equipment will be incorporated into and part of the monthly payment.

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      The views and opinions expressed in this blog are those of the authors and do not necessarily reflect the official policy or position of Lendio. Any content provided by our bloggers or authors are of their opinion and are not intended to malign any religion, ethnic group, club, organization, company, individual or anyone or anything. The information provided in this post is not intended to constitute business, legal, tax, or accounting advice and is provided for general informational purposes only. Readers should contact their attorney, business advisor, or tax advisor to obtain advice on any particular matter.

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      Lendio

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