What’s the Difference Between Equipment Leasing and Equipment Loans?

Equipment Leasing vs. Equipment Loans

With an equipment lease, a lender buys a piece of equipment, then rents it out to you for a monthly fee. At the end of your lease, you can choose to purchase the equipment at its fair market value. With an equipment loan, your lender will front you the capital to pay for the purchase of a piece of equipment. Once you’ve repaid your loan according to its terms, you’ll fully own your equipment.

You might think of equipment as strictly heavy machinery. But from a small business loan perspective, so many tools of so many trades fall under the “equipment” umbrella. Ovens, trucks, IT software, office furniture and fixtures, kitchen appliances, HVAC units, company cars, espresso machines… basically, if you run a business, you need some breed of equipment to keep your outfit updated and running smoothly. But the cost for all that equipment piles up, and it’s tough—even impossible—to pay for everything, in full, using your own capital. That’s where equipment financing comes in.

Actually, though, you have your pick of equipment financing methods: You can consider either equipment leasing, or an equipment loan. Yes, there’s a difference between equipment leasing and equipment loans!

Essentially, equipment leasing is a rental agreement. And equipment loan, also known as equipment financing, is a monetary loan, which helps you pay for the purchase of a piece of equipment.

That’s your quick-and-dirty answer. But as it turns out, the difference between equipment leasing and equipment loans is slightly more involved than that. We’ll show you those differences, and help you figure out which equipment financing route makes the most sense for your business.

The Major Difference Between Equipment Leasing and Equipment Loans

As we mentioned, equipment leasing and equipment loans are two different financing products; both give you immediate access to expensive equipment, but they’re structured in completely different ways.

Here’s what the difference between equipment leasing and an equipment loan really comes down to:

With an equipment lease, you don’t own the equipment outright. Rather, a lender buys a piece of equipment, then rents it out to you, for a flat monthly fee. At the end of your lease, you can choose to purchase the equipment at its fair market value. (You can choose a few other options, too, which we’ll get into later.)  

If you opt for an equipment loan, on the other hand, your lender will front you the capital to pay for the purchase of a piece of equipment. Depending on what you’re buying, your lender can loan you all, or most, of the total value of your equipment. You’ll pay down your loan, plus interest, over time. Once you’ve repaid your loan according to its terms, you’ll fully own your equipment.

All told, an equipment lease lets you pay for the use of equipment for as long as the lease lasts, not necessarily for the ownership of that equipment. An equipment loan helps you pay for a piece of equipment outright. (Like any other small business loan, though, you’ll need to repay your lender what you’ve borrowed, as well as interest.) You can kind of think of an equipment lease as renting out an apartment, and an equipment loan as buying a house.

The difference between equipment leasing and equipment financing doesn’t end there, though. Here are a few more key details about each financing product.  

What You Need to Know About Equipment Leasing

If you think that the equipment you need will become outdated in a few years’ time, then there’s no need to buy it! Instead, you can opt for an equipment lease, which allows you use of that conveyor belt, slushie machine, food truck, etc. that you need for a predetermined, but finite, amount of time. Typically, equipment leasing agreements typically last between two and seven years, but it certainly won’t outlast the equipment’s value.

The Upside to Equipment Leasing

No down payment or collateral: If you’re looking to finance a piece of expensive equipment, there are lots of reasons to consider equipment leasing. First off, an equipment lease generally requires no money down, and no additional collateral to secure. That means you can keep a good chunk of your cash to contribute to your business’s other expenses, and you don’t need to risk any of your business or personal assets to secure this rental agreement.

Easy application process: The equipment leasing application process is fairly simple, too—you likely won’t need to provide as much financial paperwork as you would if you applied for a traditional small business loan. Plus, equipment lenders will usually consider applicants with challenged credit.

Flexible terms: Most lease agreements include several options after the lease ends. You can choose to:

• Purchase the piece of equipment at its fair market value. If you choose to buy the equipment you’ve been renting, the lender releases the title to the equipment to you
• Continue to lease the same piece of equipment
• Return the equipment
• Trade in your current equipment for a new or updated piece of equipment

That last point is one of the major advantages of equipment leasing. Ultimately, you’re under no obligation to hold onto the equipment you’re renting, since you don’t actually hold the title to that piece of equipment. So, if you’ve found that whatever you’ve been renting—say, a hyper-specific piece of machinery or software—has become obsolete over the course of your lease agreement, you can easily return it. Then, the equipment leasing company can finance a newer model for you.    

The Downside to Equipment Leasing

Of course, an equipment lease isn’t a perfect deal—nothing ever is!

Because a lease isn’t a loan, you won’t pay interest on your monthly payments. However, lenders offering equipment leasing will bake an effective interest rate into those flat monthly payments; it’s how the lender makes money off their deals.

The price of your equipment leasing deal will depend on a few factors in your application, like your personal credit score, your business’s annual revenue, and its age. For the most part, though, lenders determine the cost of your loan based on the value of the equipment they’re buying, how well or poorly that equipment holds value, and the length of the lease.     

Depending on where the lender prices your monthly fee, you might end up paying significantly more over the course of your equipment leasing deal than you would if you’d paid for that equipment upfront.

What You Need to Know About Equipment Loans

Unlike an equipment lease, equipment financing is a monetary loan that helps small business owners pay for a piece of equipment over time. If your lender approves your equipment loan application, they’ll front you 80% to 100% of the cash you need to buy your equipment.

Then, you’ll repay that loan amount, plus interest, over a predetermined amount of time. The length of your equipment loan mostly depends on how long your lender anticipates that the equipment you’re buying will be valuable. Once you’ve paid off your loan, you’ll fully own that piece of equipment.

Equipment Loans: The Pros

Time: The most obvious upside to opting for an equipment loan is that this loan agreement gives you the time to pay for an expensive piece of equipment, which you wouldn’t otherwise be able to pay for upfront. And, at the end of your deal, you’ll own that equipment—unlike an equipment lease, which is really a rental agreement.

(Relative) of qualification: Equipment loans are generally easier to qualify for than traditional term loans, and most equipment lenders are happy to consider business owners with challenged credit. That’s because equipment loans are self-collateralized—if a borrower defaults on their loan payments, then the lender can seize the equipment they’re financing, and liquidate it, to retrieve their lost money.

That built-in safety net lessens the lender’s risk of losing everything if the borrower defaults (which is unlikely, but not totally out of the question). For that reason, equipment lenders are a bit less strict about things like a business’s average annual revenue, age, and the business owner’s personal creditworthiness during their vetting process.

That doesn’t mean lenders don’t care about those stats—they don’t really want to have to repossess your equipment. However, when they’re considering a loan candidate, they’re mainly concerned with the resale value of the equipment they’re financing, and the higher the resale value, the lower the APR. The equipment’s resale value determines how much money a lender is willing to extend you—where, you guessed it, the higher the resale value, the more money they’re willing to loan you.   

No collateral needed: Since equipment loans are self-secured, your lender probably won’t ask you to offer up any additional collateral to secure your loan, either.

Equipment Loans: The Cons

Down payment: If you’re approved for an equipment loan, your lender might front you 100% of the cost of your equipment. Or, they might not. Often, lenders supply around 80% of the amount of the equipment, which means it’s down to you to pay for the remainder upfront.

The good news, though, is that the more you can throw down on your down payment, the better your chances are of scoring a lower interest rate on your loan.

Interest rate: Also keep in mind that, like any other loan, you’ll need to pay interest in addition to the principal amount of the loan. Interest rates can be as low as 8%, but they may also shoot as high at 30%.

Your interest rate does depend on your qualifications—we’re talking the usual suspects, like credit score, time in business, and average annual revenue. Mostly, though, your APR has nothing to do with your stats; it depends on the resale value of the equipment your lender is financing.

You’re stuck with that piece of equipment!: Before you apply for a loan to buy a specific piece of equipment, be sure that it’ll retain its value by the end of your loan’s terms. Otherwise, you’ll be tied to an outdated tool that you might need to pay to replace.

Equipment Leasing or Equipment Loans: Which is Right for Your Business?

If you’re itching for a new piece of equipment stat, but you’re fresh out of funds to pay for it upfront, don’t worry! You have options. Shoot for either an equipment lease, or an equipment loan.

As you now know, there are a few differences between equipment leases and equipment financing. And there are upsides and downsides to both.

Of course, you’ll have to weigh both sides of the coin, both for equipment leasing and equipment loans. But the more direct route to your answer is to consider these two factors: how much money you have available right now; and how quickly the equipment you’re eyeing will become outdated.    

If you have the money for a down payment, and the piece of equipment you intend to finance will last your business a long time, then an equipment loan may be the way to go.

But if you have little money to put down, and/or the piece of equipment you intend to finance will quickly become obsolete, then you may want to consider equipment leasing instead.

Keep in mind that both equipment loans and equipment leasing can offer tax incentives, too. As you’re well aware, taxes can get tricky, so speak with an accounting professional if you have questions about which option is right for you from a tax perspective.

The post What’s the Difference Between Equipment Leasing and Equipment Loans? appeared first on Fundera Ledger.

from Fundera Ledger https://www.fundera.com/blog/difference-between-equipment-leasing-and-equipment-loans