The age-old question of lease versus loan is very common, and one that can’t be answered with a simple one-word response. Everyone who has ever considered leasing has had this question cross their mind. So what is the answer?
It really depends on your specific situation. Leases and loans are simply two different methods of equipment financing. One finances the use of the equipment, while the other finances the purchase of the equipment. Each has its own benefits and drawbacks. You’ll need to take a look at your own situation and preferences.
There are not only the financial comparisons to keep in mind, but you’ll also need to ask yourself what’s important to you.
Would you prefer to have a new piece of equipment every two or three years, or is long-term cost your issue? Are long-term cost savings more important than lower monthly payments? Is ownership more important than low up-front costs and no down payment?
Before you decide which option works better for you, there are several things to keep in mind. When comparing lease vs loan, or bank vs lease for the lowest rates, it’s important to understand following key terminology and points.
Rate Structure: Banks are not known for their flexibility and risk taking. They prefer to loan money long-term on a floating or variable rate tied to prime. This places the risk on you instead of the bank. Lease rates are fixed on the day you sign your agreement and your payments will not change throughout the term of your lease.
Soft Costs: Banks are comfortable loaning money for hard assets, but they aren’t in the business of loaning money for some important peripherals like shipping, installation, software, etc. Leasing is 100% financing and can cover all soft costs.
Down Payment: Banks typically require 10-25% down on any equipment financing. Banks are again trying to lower their risk and put the onus on you. Banks are not concerned about your practical business needs (eg, retention of working capital). Leasing is 100% financing and rarely requires more than first and last payment upfront.
Compensating Balances: In order to get a low rate with your bank you may be required to maintain certain minimum balances. Banks are smart. By doing this, they pay you no, or low, interest on the balance in your account. This not only inflates their actual yield well above your loan interest rate, but it also ties up your working capital. Leasing has no such requirement.
Restrictive Covenants: Most bank loans have many restrictions and covenants, such as maintenance of certain financial ratios, restrictions on future debt and salary restrictions. Additionally, look for “Call” provisions, which banks incorporate that give them the right to demand an early payoff of your loan for reasons you have no control over. Leasing has none of these types of provisions.
Revolving Loan: Banks prefer to classify a loan as a “Revolving” loan. This gives them the ability to extend or cancel the loan on a yearly basis. This means annual submission of Financial Statements for review and approval. Additionally, this loan is now a current liability, which really messes up your financial ratios. Leasing is fixed long-term financing.
Blanket Lien on Business: Banks take a security interest in all of your company’s assets (presently owned and acquired in the future) by publicly filing a General Security Agreement. This ties up all of your assets, including inventory and receivables. Leasing files a Personal Property Security Agreement only on the leased equipment.
Disclosure: Banks want a full financial package to help them make their credit decision on your loan. Leasing typically only requires a one-page application in order to approve a lessee up to $30,000.
Lending Limits: Banks determine a maximum borrowing limit for the company, and usually the principals as well. Once that limit has been reached you can be restricted from future borrowing. Leasing offers alternative lending options without tying up your working capital or lines of credit.
Credit Review Process: The bank credit review process can be long and tedious with much back and forth requesting of further information. Leasing usually takes 12 hours or less for an approval.
Tax Write Off: When you use bank financing you become the owner of the equipment. Your only tax advantage is depreciation and the loan’s interest. Lease Payments may be 100% deductible or may be a form of accelerated depreciation depending upon the lease type and your company’s financial structure.
As always, I’m here to help, so please send your leasing questions my way!