Equipment financing allows business owners to acquire business-related assets, spreading the cost over a longer period. Financing can come in the form of a loan or a lease. Loans allow business owners to retain ownership of the equipment once the balance is fully paid, whereas leases can provide options for returning, upgrading, or purchasing the equipment at the end of the lease term.
Loans and leases each have its own set of pros and cons. For instance, loan terms and fee structures can vary, so the best option will depend on your specific business circumstances. Read on to see our comparison of loans and leases to help you figure out the best fit for your company.
How does equipment financing work? Lenders issue funding based on the value of the equipment. The equipment also serves as collateral for the loan, giving the lender the ability to take it in the event of a loan default.
Who Equipment Financing Is Right For
Taking advantage of equipment financing can help your business grow, but you’ll need to ensure the benefits outweigh the costs. Here are some circumstances that might indicate equipment financing can be a good option for your company:
- You require equipment to help run your business: Equipment financing can be used to help you acquire items that are needed to run your business. Some examples of this can include computers, vehicles, machinery, and other specialized equipment.
- Your business is expanding: Additional equipment can help meet the growing needs of an expanding business. This can help increase production to continue growing revenue and sales.
- You want to finance the costs over a long period: Equipment financing helps you acquire new equipment at a lower upfront cost. If you don’t have enough funds to purchase equipment outright, equipment financing can help you spread the costs over a period of several years.
- You have bad credit: Getting equipment financing with bad credit is easier because the loan is secured by the equipment you’re getting. This makes it less risky for lenders in the event of a default. Check out our recommendations for the best equipment financing companies for bad credit.
- The equipment you need will have a high return on investment (ROI): In addition to the purchase price of the equipment, financing it carries certain costs, so you’ll want to ensure that your expected ROI is sufficient to cover these expenses.
- You need to upgrade your equipment regularly: If you’re in an industry that needs to upgrade equipment regularly to keep up with competitors, leasing can be a more cost-effective, long-term solution as you’ll typically have options to upgrade, renew, or even purchase the equipment at the end of the term.
What Is an Equipment Loan
An equipment loan allows you to purchase a business asset and retain ownership of it once the loan is paid off. You’ll become the legal owner of the equipment and can keep and use it for as long as you wish.
With an equipment loan, paying off the balance in full may give you the ability to use the asset as collateral for other loans. This can help you improve your approval odds for subsequent financing needs, as well as get you qualified for more competitive rates and terms.
See our guide on equipment loans to learn more about how these loans work and who they’re right for.
Pros & Cons of an Equipment Loan
PROS | CONS |
---|---|
Has simpler financing terms that allow you to become the owner once balance is paid off | Carries a more difficult path for upgrading equipment |
Comes with lower long-term costs compared to leasing | Has down payment requirements that tend to be higher compared to leases |
Offers easier qualification requirements compared to equipment leasing | Comes with monthly payments that tend to be higher than leases |
What Is Equipment Leasing
With an equipment lease, you’ll be able to acquire business equipment without needing to purchase it. It allows you to rent the equipment, but you’ll typically be required to return it to the vendor once the lease expires.
Depending on the terms of the lease, you could also have the option to purchase, renew, or upgrade the equipment once the initial lease term expires. There are different types of equipment leases, each with a different set of options and fee structures. For more details, head over to our detailed guide on equipment leasing.
Below we’ve summarized some of the most common types of equipment leases and how they work:
- $1 buyout lease: With this type of lease, you have the option to purchase the equipment for $1 at the end of the lease term. Payments tend to be higher but can help with spreading the cost of equipment into more manageable payments.
- 10% option lease: Once the initial lease expires, a 10% option allows you the flexibility to purchase the equipment for 10% of its value. The valuation is based on the initial purchase price.
- 10% purchase upon termination (PUT) lease: This is similar to a 10% option lease, but instead requires you to purchase the equipment at the end of the lease for the remaining value of 10%.
- Fair market value (FMV) lease: With an FMV lease, you have the option to buy the equipment based on its current fair market value once the lease term expires. One of the potential downsides with this is the fact that the FMV value is not known upfront.
- Terminal rental adjustment clause (TRAC) lease: A TRAC lease, often used for vehicles, gives business owners the option to select payment amounts based on what they want the final lump-sum payment to be.
Pros & Cons of an Equipment Lease
PROS | CONS |
---|---|
Provides an easier path to regularly upgrade equipment | Has long-term costs that can exceed those associated with purchasing equipment |
Can be less expensive than using an equipment loan for a purchase | Comes with terms that can be more difficult to understand compared to a loan |
Requires a smaller down payment, allowing you to keep more cash on hand | Can be more difficult to qualify for compared to a loan |
Equipment Loans vs Leases: Rates, Terms & Qualifications
Rates, terms, and qualification requirements for an equipment loan or lease will vary from lender to lender. However, you’ll find that there will be some common trends when it comes to the differences in getting equipment loans vs leases. We’ve summarized typical figures you’ll see among equipment financing companies.
Typical Equipment Loan | Typical Equipment Lease | |
---|---|---|
Origination Fees | Up to 3% of the loan amount | 0% to 3% |
Interest Rate | 5% to 35% | 4% to 30% |
Loan Amount | Up to $5 million | |
Loan Term | 2 to 7 years | |
Down Payment | 0% to 30% | 0% to 20% |
Credit Score Requirement | 600 | 500 |
Time in Business Requirement | 0 to 12 months | 12 to 24 months |
Annual Revenue Requirement | Varies per lender | |
Funding Speed | 1 to 7 days |
If you want to have multiple financing options, we recommend working with a loan broker like Smarter Finance USA. It can offer many different options for loans and leases thanks to its network of nearly 40 lenders, something that helped it land a spot on our list of the best equipment financing companies. You’ll also be paired with a funding specialist to help you choose the best type of loan for your needs.
Equipment Loans vs Leases: When To Choose Each
The decision to get an equipment loan or a lease can impact the cash flow of your business from both a revenue and expense perspective. Loans and leases have varying costs for things like one-time down payment requirements and ongoing recurring payments. Your revenue can also be impacted by your choice of either a loan or a lease, as having outdated equipment can put you at a disadvantage to competitors.
When To Consider an Equipment Loan
- You don’t need to upgrade your equipment regularly: When an equipment loan is paid off, you’ll be able to retain full ownership of the equipment. This can help you keep your long-term costs down, especially if the equipment has a long expected useful life.
- You want to retain full ownership of the equipment: Retaining ownership of equipment long-term can give you the flexibility to use it in any manner you wish, as ownership carries fewer restrictions compared to leasing.
- You have enough funds for a down payment and can afford larger monthly payments: Purchasing equipment with a loan tends to be more expensive than a lease. Down payment requirements generally are higher, as are the monthly minimum payments.
When To Consider an Equipment Lease
- You only have a temporary need for the equipment: With many leases, you can return the equipment at the end of the term with no further financial obligations. Leasing can therefore be a good option if you’re unsure of the long-term use case for your business equipment.
- You plan on upgrading the equipment frequently: Many leases have the option to easily upgrade equipment. This is especially helpful in industries where technology advances quickly.
- You want to have smaller monthly payments: Since you won’t always be able to retain ownership after the lease expires, leases tend to have lower monthly payments. This can help you acquire business equipment at a lower cost in the short term.
Frequently Asked Questions (FAQs)
With equipment financing, a lender issues funding based on the value of the equipment. Lenders often use a Uniform Commercial Code (UCC) filing to secure their interest in the collateral, giving it the ability to take possession of the equipment in the event of a default. For detailed information, check out our guide on how to get a small business loan for the steps involved and tips for improving your approval odds.
With an equipment loan, you retain ownership of the asset once the loan is paid. An equipment lease, on the other hand, typically requires you to return the equipment to the vendor at the end of the lease term. Some leases, however, provide additional options to purchase, renew, or upgrade equipment.
Equipment loans may be a better option if you want to retain full ownership of the equipment or do not need to upgrade equipment regularly. Meanwhile, equipment leases may be a better fit if the equipment is something that will easily become outdated, you want the option to walk away from the equipment after a short period, or you want the flexibility of lower monthly financing payments.
Bottom Line
Equipment financing can allow you to acquire business equipment that’s necessary to grow your business. Each allows you to spread the costs of the equipment over a longer period, giving you the ability to retain funds for emergency uses or for investment into other areas of your company. You’ll have the option to choose between an equipment loan or lease, and the best one will depend on your specific business needs and goals.