If your business uses vehicles, machinery, or just about any other kind of equipment, you may be considering business equipment leasing as a way to cut your monthly payments. Business equipment leasing can be a solid way to supply employees with what they need to get the job done, but it’s not necessarily the most cost-effective over the long run.
Before you sign an agreement, it’s important to be aware of the pros and cons. Here’s everything you need to know about business equipment leasing.
1. What is business equipment leasing?
Business equipment leasing is a type of financing that helps small business owners rent equipment, such as heavy machinery or vehicles. Leases come with a set time duration. Once the lease is up, you’ll have to return it, buy it, or renew your lease.
Business equipment leasing is different from equipment financing—which involves taking out a loan to purchase the equipment, using it as collateral, and paying off the loan over a fixed term. Once the agreement is paid off, you own the piece of machinery.
This type of leasing comes with lower monthly payments but is also more expensive in the long run than financing. At the end of the term, you’ll have to return the equipment instead of having the option to keep or sell it.
2. How does business equipment leasing work?
Business equipment leasing works like a rental agreement. It allows business owners to rent equipment, such as vehicles and machinery, from a vendor for a specific amount of time, after which the equipment will be returned to the vendor.
The equipment leasing business model involves entering into an agreement with a financing company or vendor. The details of how long you’ll be able to use it and how much you’ll pay each month will be outlined in the contract.
It’s important to keep in mind that an equipment lease is temporary. Once that period ends, you’ll have to decide whether you want to buy the equipment, renew the agreement, or find another vendor.
Business equipment financing works in a different way. With this solution, you’ll obtain a loan to purchase a piece of equipment, which you then pay off over time. Essentially, you’re paying to own an asset, which you can then use as collateral, continue using, sell, or more.
3. How is an equipment lease calculated?
An equipment lease is calculated taking into account the current value and the residential value of the equipment, as well as the interest rate and the term of the loan. The equation looks like this…
Payment = Present Value – (Future Value / ( ( 1 + i ) ^n) / [ 1- (1 / (1 +i ) ^ n ) ] / i ))
where the “i” is the interest rate represented as a decimal and the “n” is the number of payments.
Many entrepreneurs will opt for business equipment leases because they tend to feature lower monthly payments. However, that doesn’t necessarily mean that a business equipment lease is automatically the cheaper solution. In fact, they’re generally more expensive over the long run when compared to financing outright.
It helps to have an understanding of how much a business equipment lease will cost you, especially on a month-by-month basis. Your lender will typically calculate your equipment lease by taking into account the following factors:
- The equipment’s current value
- The equipment’s residual value, or the value it will have at the end of the lease
- Interest rate
- Length of the lease
Lowering your interest rate and extending the length of your lease will contribute to a lower monthly payment and vice versa.
3.1. What is a lease payment factor?
A lease payment factor, also called a lease rate factor, refers to the regular lease payment as a percentage of the total cost of the equipment lease. It represents the required payment you’ll need to make on a monthly basis for your lease.
Lenders can determine the lease rate factor in a number of ways but will typically take the following into account:
- The equipment’s current value
- The equipment’s depreciation rate
- Interest rate
- Length of the lease
You can calculate your monthly payment by multiplying the lease rate factor and the current price of the equipment you are looking to lease. For example, if you receive a lease rate factor of .025 and a piece of equipment costs $10,000, your monthly payment would be 10,000 x .025 = $250.
3.2. What is a good equipment lease rate?
Average business equipment lease rates can range between 5% to upwards of 15%. In general, anything between 5% to 9% can be considered a good equipment lease rate.
Your credit score will have a major impact on whether or not you’re able to secure a good equipment lease rate. Interest rates of 10% or higher are common for borrowers with less than great credit.
4. Types of Equipment Leasing
There’s more than one type of lease. Before signing an agreement, be sure to ask questions and learn about various options.
The type of lease you choose could have implications when it comes to accounting and bookkeeping. Different companies may offer various products, but these are the most common types of equipment leasing arrangements.
4.1. Operating Lease
An operating lease, or fair market value lease, entails renting the machinery or hardware. You won’t receive any benefits of ownership throughout the duration of your lease. However, once it ends, you’ll have the option to return the equipment or buy it at its fair market value.
Operating leases are generally shorter than the economic life of the equipment. Most operating leases are between 1 to 3 years and generally no more than 5 years. Your equipment won’t be accounted as either an asset or a liability. Instead, it will simply be considered a rental expense. However, you may be able to qualify for certain tax advantages, nonetheless.
4.2. Capital Lease
Capital leases are structured very similarly to an operating lease. However, the main difference is that the equipment will be considered an asset on your business’s balance sheets. You’ll also have the option to buy the equipment at the end of the lease period.
Capital leases can be especially tax advantageous. You may be able to claim both the depreciation tax credit on the equipment and the interest expenses on the lease itself. Given these benefits, capital leases tend to come with higher APRs than operating leases. Monthly payments are also higher and can be closer to an equipment loan.
5. What are the advantages and disadvantages of business equipment leasing?
You know your business needs new equipment, but you’re not sure if leasing is the right way to get it. How can you make the right decision? Take a look at the advantages and disadvantages of leasing equipment to understand if it’s the right move for you or if an alternative like equipment financing might be the better way to go.
Lower Monthly Payments
Even though equipment leasing is more expensive in the long run, the monthly payments are lower. It may be a good option for small businesses struggling with cash flow.
No Down Payment Required
Most likely, you will not have to come up with a down payment or collateral to secure an equipment lease. That being said, there are many equipment financing programs that also don’t require down payments.
However, leasing companies will take other factors into consideration, such as your credit score and balance sheets.
Ability to Upgrade Equipment Frequently
Short-term leases allow you to trade out a piece of equipment for an upgraded one. If working with the latest hardware is important for your business, then getting an equipment lease might make sense.
Through equipment financing, though, you’ll also have the option to sell equipment once you own it, then upgrade to the latest model.
Fixed Interest Rate
With equipment leasing, interest rates are automatically incorporated into monthly payments. Your interest rate is also fixed, giving you a clearer understanding of your future expenses.
Equipment leasing payments are tax deductible. However, buying equipment also comes with favorable type of financing – which are even more generous than those on leases.
You may be able to fully deduct the cost of a newly purchased asset in the first year. You can also qualify for depreciation deductions on purchased machinery.
Equipment Leasing Is More Expensive
While monthly payments on an equipment lease are lower, the total cost always ends up being greater than if you were to finance the equipment. After all, you’re paying toward ultimately owning the equipment.
If you’re looking to save money in the long run, equipment financing might be a better option.
When the Lease Ends, You’ll Have No Equipment
At the end of your lease, you’ll need to make other arrangements if you still need to use the machinery. You’ll have to decide between renewing your lease, buying the equipment, or looking into other equipment leasing companies.
Strict Terms and Conditions
Equipment lease agreements come with rigid rules. You may face penalties if you try to get out of your lease before the end date—or you may be unable to cancel it altogether. It’s not uncommon for businesses to have to keep making payments on their lease, even if they’re no longer using the equipment.
The agreements may also detail specific upgrades you are required to pay for or specify how you can and can’t use the machinery.
The Equipment Isn’t An Asset You’ll Own
With equipment loans, your payments go towards owning the hardware. Once the loan is paid off in full, you could sell the equipment, exchange it, or do just about anything else.
Having an asset on your balance sheets also brings additional perks when it comes to obtaining financing in the future. Unfortunately, you won’t gain any of these benefits when you lease.
6. Is equipment financing a lease?
No, equipment financing is not the same as business equipment leasing. With equipment financing, you’re getting a loan to purchase the equipment outright. In a way, equipment financing is similar to a mortgage since the underlying asset will act as collateral for the loan.
Business equipment leasing is essentially a rental agreement. Your monthly payments are not going towards owning the asset outright. Instead, you’ll need to return your equipment at the end of the lease period.
Take a look at how business equipment financing vs. leasing compare.
6.1. Business equipment financing
- Larger monthly payments, but less expensive over the long run
- You’ll need cash for a down payment
- At the end of your loan period, you’ll own the equipment outright
- You’ll be able to use the equipment as you see fit
- You’ll be able to sell the equipment when the time comes
- Ideal if you’re looking to invest in equipment that will stay with your business over several years
6.2. Business equipment leasing
- Smaller monthly payments, but more expensive over the long run
- No down payment required
- You’ll be able to change out your equipment regularly for newer models
- Ideal if the equipment you use depreciates quickly, and it doesn’t make sense to invest
7. How can I apply for business equipment leasing?
Looking to apply for business equipment leasing but don’t know where to start? Here’s a breakdown of what to expect.
Step #1: Find your equipment
A good place to start is by pinpointing exactly the type of equipment you’re looking to obtain for your business. You’ll need to know how much it will cost, its expected lifetime, and whether or not the equipment will require frequent repairs.
If possible, make a list of more than one model in case your ideal match is sold out or difficult to obtain.
Step #2: Find an equipment leasing company
Research different equipment leasing companies to get an understanding of your options and chances of qualifying. Banks, online lenders, and even equipment manufacturers and vendors are known to offer business equipment leasing.
Make sure to compare different providers, review their qualifications, and read online reviews to ensure you’re working with the right company.
Step #3: Gather your documents
Once you’ve selected your leasing company, make sure to discuss the documents you’ll be required to provide. In general, you’ll likely be asked to show information on the type of equipment you are leasing as well as your business.
This can include documents such as business tax returns, bank statements, and the equipment price quote.
Step #4: Obtain approval and receive your lease
Submit your business equipment leasing application, and – if all goes well – you should be on your way to obtaining approval. Make sure to review your leasing agreement thoroughly before signing.
You’ll want to take the time to understand the fees, terms, and how you’ll be expected to make payments.
How to Apply for Equipment Leasing
National is an online marketplace that helps you secure the best rates, terms, and funding amounts on all your small business financing needs—including equipment leasing and financing.
Talk to one of our expert Business Financing Advisors about your options for getting the equipment you need to drive revenue.
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Frequently Asked Questions
Is it hard to get business equipment leasing?
Not necessarily. However, having good credit will improve your chances of qualifying for business equipment financing and allow you to secure the best rates.
What credit score do you need to lease equipment?
In general, you’ll need a credit score of at least 650 in order to lease business equipment. However, business equipment financing options may be available if you have lower credit. Get in touch with National to learn about your options.
Do you need a good credit score to lease equipment?
You may be able to find some companies willing to lease you equipment despite having poor credit. However, in general, the stronger your credit score, the better your approval odds and chances of obtaining lower interest rates.
How do I get equipment leasing for startups?
The process for obtaining equipment leasing for startups is generally the same as any business applying for equipment leasing. However, you may have a harder time qualifying if your credit and business history are lacking.
It can be worthwhile to explore your options for equipment financing through National, where you can find many solutions specific for startups.
What is equipment lease to own?
Also known as a capital lease or an equipment finance lease, these arrangements are where you enter a business equipment leasing agreement and retain the option to purchase the machinery at the end of the contract.