Equipment Loans VS Equipment Leases: Which Is Right For You?

Most businesses need equipment, whether it’s kitchen appliances or heavy equipment to be used on a construction site. Purchasing these items can be expensive and may require a loan. On the other hand, a traditional loan may not be the best way to purchase equipment that may soon become obsolete.

In this post, we’ll look at equipment loans and leases, discuss the benefits and drawbacks of each, and help you decide which equipment financing option is right for your business.

What Are Equipment Loans & How Do They Work?

An equipment loan is a loan that is used to purchase equipment. What distinguishes equipment loans from other loans is that the equipment itself serves as collateral. If you can’t make your payment, the lender simply repossesses the equipment. With some lenders, a blanket lien is also required.

Most equipment loans don’t cover the entirety of an item’s cost, so a down payment of 10% to 20% may be required.

Once the loan is paid off, the equipment is yours to use or resell. For items that don’t depreciate quickly, this is a pretty good deal. For equipment that will quickly become obsolete,  an equipment loan can be a bad investment.

An equipment loan can also be costly. In addition to the down payment, you’ll be paying back interest plus any origination fees charged by the lending entity.

Choose An Equipment Loan If …

What Are Equipment Leases & How Do They Work?

A lease is a contract that guarantees the lessee (you) the use of the lessor (the owner’s) equipment for an agreed-upon term in exchange for payment. Lease agreements can be made in as little as a few hours, depending on the availability of the equipment and the amount of background checking involved.

Unlike loans, many equipment leases don’t require collateral or down payments, so there’s less of an upfront investment for you to make. Since the lessor still technically owns the item, they’re responsible for reasonable maintenance of it, assuming you’re using it in accordance with the lease.

At the end of the lease, you have the option to either buy or return the equipment. If you think the equipment is worth keeping long-term, you buy it outright. After that, you own it. If you no longer want the equipment, you can return it. Some lessors will also give you the option to renew or extend your lease.

When it comes to buying equipment once your lease is up, there are a number of variations. The most common are:

• $1 Buyout Lease: These are very similar to loans in that the entire cost of the item will probably have been figured into your interest rate and term length. When your lease is up, you make a symbolic purchase by paying the lessor a dollar.
• 10 Percent Option Lease: Similar to the previous, except that less of the cost of the product is built into the lease, which usually translates to lower interest rates. You pay 10 (or some other) percent of the equipment’s cost.
• Fair Market Value (FMV) Lease: These leases usually pair comparatively low rates with a fair market value buyout clause. FMV is roughly equal to what an informed consumer would expect to pay for the equipment at the end of the lease. Since the lessor assumes a bit more risk here, your credit rating may factor more heavily.

Leases tend to be more expensive than loans in the long run, but you must calculate the advantages of owning and maintaining the product versus using and returning it.

Choose An Equipment Lease If …

Equipment Loans VS Leases: Which Is Right For Your Business?

Here’s an example of the terms you might see for both an equipment loan and an equipment lease on a $12,000 item, assuming you want to own the equipment eventually.

By spreading the cost of the equipment out over two years, you’re paying a premium either way. However, you’ll notice a few tradeoffs. In the case of the loan, you’re paying a lower interest rate on a smaller amount of money — $10,000 vs. $12,000 — but you have to have coughed up $2,000 in advance.

While the lease looks like an inferior deal overall, there are a few caveats to consider. If you don’t want to eventually own the equipment, you can subtract $1,200 from the cost (though you won’t be left with an asset at the end of the term). And you won’t be responsible for repairs for the duration of the lease as you would be if you had taken out a loan on the equipment.

Deciding whether to sign a lease or take out a loan can be a bit of a gamble, but if you factor in the value (or lack thereof) of owning the equipment long-term, you’ll be able to make the best decision for your company.

Ready to get started? Check out our picks for best equipment financing to find great loan and lease options that may be a good fit for your business.