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Equipment Leasing vs. Financing: Which Makes Better Sense?

business people working in the office

For most businesses, the ability to keep operations running smoothly hinges on having the right equipment. When a key piece of equipment breaks down or becomes outdated, replacing it may be necessary.

If you're not sitting on a pile of cash that allows you to purchase the new equipment outright, there are two options available for getting the equipment your business needs: You can lease it or you can finance its purchase. Each has advantages and disadvantages, and it's important to weigh both sides before making a final decision.

Equipment Leasing Basics

Leasing equipment for your business is similar to leasing a car. You sign a contract with the leasing company, agreeing to lease the equipment for a set number of months. You make a monthly payment in exchange for use of the equipment. At the end of the lease term, you can renew the lease, purchase the equipment, or simply walk away.

Leasing Pros:

  • You're not committed to the equipment long-term. If your business requires new equipment on a regular basis, leasing makes it easier to upgrade to the latest technology.
  • Lease payments may be 100% tax-deductible as a Section 179 deduction, which can prove valuable at tax time.
  • You're not responsible for paying normal wear and tear or maintenance costs on the equipment. The leasing company covers those costs.
  • A down payment isn't always required and, if one is, it may be less than a down payment for an equipment loan. The monthly payments may also be less than a loan, allowing you to preserve your cash flow.

Leasing Cons:

  • Unless you decide to purchase the equipment, you won't own anything at the end of the lease term. You wouldn't be able to sell the equipment to get back any of the capital you've invested.
  • You may pay more for leased equipment over the long term, than you would if you purchased it outright, once interest and fees are factored in. For example, leasing a $100,000 piece of equipment for 24 months with an 8% APR would cost you over $6,000 more than buying the same equipment with a 60-month loan at 6%.
  • You may still be obligated to fulfill the lease term, even if you no longer need the equipment.

How Equipment Financing Works

Equipment financing refers to business loans that are designed specifically for purchasing equipment. The equipment itself typically serves as collateral for the loan and you may be able to borrow up to 100% of its value. The repayment period may extend for the life of the equipment, and the APR you'll pay can be similar to other types of business loans.

Financing Pros:

  • You're making payments on something you own, which is an advantage if the equipment is something your business uses regularly that isn't likely to become outdated any time soon.
  • The full purchase price of the equipment may be tax-deductible under the Section 179 provisions. If you can't deduct the cost, you could still deduct depreciation and the interest paid on the loan.
  • The overall cost may be lower and, if the equipment is the collateral for the loan, you won't have to offer up any of your other business assets to secure financing.
  • Being able to stretch out payments over an extended term could be less stressful on your monthly cash flow.

Financing Cons:

  • An initial down payment of 10 to 20% may be required for an equipment term loan. If you're buying a $500,000 piece of equipment, that's a sizable amount of cash you'd have to part with. You should also consider whether the lender charges an origination fee, which can add to the cost.
  • You'd still be responsible for the loan even if the equipment becomes obsolete, and you shoulder all the financial burden for repairs and maintenance.

Should You Lease or Finance Equipment?

Both leasing and financing can solve your equipment problems, although neither may be a perfect solution. So, how do you decide which one is better for your business?

The answer ultimately depends on the particulars of your situation, such as how much cash you have available for a down payment, how long you anticipate needing the equipment, and how likely you are to qualify for a loan versus a lease.

Another way to consider it is in terms of your return on investment, or ROI.

To decide between leasing and financing, it's helpful to calculate the total cost of both options, and then compare that to how much value the equipment is likely to add in terms of growing your business or driving revenue.

You'll also want to consider the effect of each option on your business's cash flow.

This analysis can shed some light on which will be the better investment.

If you're still on the fence about whether to lease or finance, connecting with a banker is the next step.