What Is Equipment Financing: Loans vs Leases
This article is part of a larger series on Business Financing.
Equipment financing is an asset-based loan or lease that allows business owners to acquire equipment for their business. Equipment financing allows you to spread the acquisition costs of equipment out over a longer period of time.
A loan guarantees the collateral―equipment, machinery, or vehicles financed―will transfer ownership at the end of the term. With a lease, the lessee has the option to walk away, purchase, or upgrade the equipment at the term’s end.
When choosing between an equipment loan or an equipment lease, you should consider the following:
- Do you want to own the equipment at the end of the financing period?
- Do you plan to upgrade the equipment regularly?
- How much cash flow flexibility does your business have?
Once you answer those questions, the sections below will help you decide whether to get an equipment loan or an equipment lease.
Terms & Rates of Equipment Loans vs Leases
Term/Rate/Qualification | Equipment Loan | Equipment Lease |
|---|---|---|
Interest Rates | 6% to 30% | 3.5% to 20% |
Origination Fees | Up to 3% of loan amount | Varies per lender |
Down Payment | 5% to 20% | 0% to 20% |
Funding Available | $10,000 to $500,000 | Up to $5 million |
Repayment Terms | Two to seven years | Two to seven years |
Minimum Credit Score | 600 | 550 |
Collateral | Equipment financed and possibly blanket Uniform Commercial Code (UCC) filing | Equipment financed and possibly blanket UCC filing |
Time in Business | At least six months | At least six months |
Annual Revenue | At least $25,000 | Varies per lender |
Whether you decide to get an equipment loan or equipment lease, Smarter Finance USA can help. [Smarter Finance USA provides both equipment loans and leases. As long as you have a credit score of at least 600 and at least 5% down, you can qualify for equipment financing with Smarter Finance USA.
Who Equipment Financing Is Right For
Whether you choose an equipment loan or equipment lease, equipment financing can help both startups and established businesses spread the cost of equipment purchases out over a longer period. By spreading costs out, you can manage monthly budgets to keep your cash flow strong without having large, one-time expenses for equipment that can damage your budget.
Businesses that can benefit from equipment financing include:
- Businesses purchasing equipment: Some businesses, such as farming, rely on specialized equipment to bring in revenue.
- Businesses that are expanding: Additional equipment may be required for your business to scale, and financing allows you to spread those costs out and get the equipment needed for your company’s growth.
- Established businesses with outdated equipment: To keep up with competitors or scale your business as it grows, you need to replace and upgrade older equipment and technology.
Even if you have bad credit, lenders are available for equipment financing. Because the equipment collateralizes the loan, it’s less risky to the lender. However, expect to pay a higher interest rate and potentially higher down payment for bad credit equipment financing.
For more information about how to get financing for your business, check out our guide on how to get a small business loan.
When To Get an Equipment Loan
When considering whether to get an equipment loan over an equipment lease, there are several factors to take into account. For example, loans are good if you want to own the collateral at the end of the financing term, you don’t have plans to upgrade the equipment, or you desire to pay the financing off early.
You Want To Own the Collateral at the End of Financing
Equipment loans are amortized, which means you make equal payments on the loan balance until the loan is satisfied. Once the loan is paid off, you own the collateral. With an equipment lease, you may not own the equipment at the end or may be required to pay a balloon payment to gain ownership.
You Don’t Plan To Upgrade the Equipment Regularly
If you plan to upgrade the equipment at the end of the financing term, a lease is the better way to go. Leasing options allow you to walk away from the collateral without paying the total amount owed.
While you can choose to pay the balloon payment and take ownership, leasing is best suited to a company that wishes to upgrade its equipment instead of taking ownership of the leased equipment. So, if you plan to pay off the equipment and keep it for a longer period of time, a loan is the right choice.
You Plan To Pay Off the Financing Early
Equipment loans don’t have prepayment penalties. So, if you plan to pay the financing off early, a loan is the right choice.
When to Get an Equipment Lease
When considering an equipment lease over an equipment loan, you have to first understand that there are many different types of equipment leases. The most common ones include:
- $1 buyout: You have the option to buy at the end of the lease for $1.
- 10% option: You have the option to buy at the end of the lease for 10% of the original value. You also have the option to walk away and not purchase.
- Fair market value: You have the option to purchase the equipment at the end of the lease for fair market value. You also have the option to walk away and not purchase.
- 10% purchase upon termination (PUT): The same as the 10% option, but you must purchase it at the end of the lease. You don’t have the option to walk away.
- Terminal rental adjustment clause (TRAC): Used typically for semitrucks, this allows a higher balloon payment at the end of the lease, making monthly payments lower.
Before choosing an equipment lease provider, determine if an equipment lease is right for your business. There are three primary reasons to choose a lease over a loan.
You Want the Option to Walk Away From the Collateral
As seen in the lease options above, several lease types allow the borrower to walk away at the end of the lease without purchasing the collateral. Therefore, if you aren’t sure whether you want to own the collateral at the end of financing―or if you’re sure you don’t want to own it―a lease makes the most sense.
You Want Lower Monthly Payments
Because leases come with balloon payments at the end, the total value of the collateral isn’t equally amortized over the life of the financing like it’s with a loan. Because there’s a balloon payment due at the end, the monthly payments are lower. In some cases, such as with the terminal rental adjustment clause (TRAC) lease, the monthly payments can be significantly less than with a loan of the same equipment.
You Plan To Upgrade the Equipment
Because you can walk away at the end of a lease without paying a large balloon payment, it allows you to immediately upgrade to a lease on a new piece of equipment. If the equipment depreciates quickly or the technology is improving rapidly, regular upgrades make the most sense for your business. In that case, a lease is the right choice over a loan.
Bottom Line
Equipment financing is crucial to the growth of a small business, as it allows you to spread the costs of acquiring new equipment over a longer period of time. This will enable you to keep your cash flow strong while purchasing the necessary equipment to keep your business competitive and growing. A handful of factors determine whether you should get an equipment loan versus an equipment lease. Consider all factors before moving forward with equipment financing.
Smarter Finance USA can help you with both equipment loans and equipment leases. You can submit your information on its website, and a customer service representative will reach out to you. You can also call a toll-free number for more information.
