Loan versus Lease:
If you don’t understand the difference between a lease and a loan, you are not alone. Many business owners continue to finance their equipment the “old fashioned” way, through loans, because they don’t fully understand the potential benefits of leasing their equipment. These benefits can be seen in four important areas: initial cost, equipment obsolescence, tax benefit and off balance sheet financing. Because of these benefits, many business owners have discovered that they do not need to own their equipment in order to conduct business – they only need to use it.
The first thing you need to know about equipment leasing is that it is 100% financing. Because a lease is essentially a “rental” of equipment, there is usually no down payment required to access the equipment your business needs. This directly contrasts most commercial bank equipment loans, which require a minimum of 10% and as much as 50% down payment. By comparison, most equipment leases will require only the first and last payment in advance of delivery. Even if you only need a small amount of equipment, this can result in a tremendous reduction in the “out of pocket expense” necessary to upgrade. This gives you the opportunity to put thousands of dollars of working capital back into your business, instead of giving it to your banker.
Another benefit of leasing your equipment is the ability to avoid “economic obsolescence.” This occurs when business equipment either cannot keep up with the demands of the market or lacks the technology to help the business remain competitive. Leasing your equipment helps to avoid obsolescence by allowing you to upgrade every few years. In other words, if the equipment appreciates, buy it. If the equipment depreciates, lease it.
In addition to the initial cost and obsolescence, leasing your equipment can also provide your business with a substantial tax advantage. While you should always consult with your tax adviser first, most equipment leases can be structured so that you can write off 100% of the annual lease payments. By contrast, current tax laws only allow a business to write off the interest paid on loans. However, because a lease is a rental and the business is only using the equipment, the business can usually write off all of the monthly lease payments just like any other legitimate business expense. Once again, this can result in thousands of additional dollars in working capital being put back into your business.
The last major advantage of leasing your equipment instead of buying is that leasing allows you to not show the equipment on your balance sheet. Once again, this is because the equipment is being rented and therefore actually belongs to a different company than the one that is using it. For this reason, leases are often referred to as “off balance sheet” financing and this can be a tremendous advantage to many businesses both large and small. Big businesses prefer this option because they don’t want to own millions of dollars in equipment. This equipment will depreciate substantially with the day-to-day usage. Whoever owns the equipment is responsible for the depreciation on their balance sheet. Also, large corporations may require that the board of directors approve any new loans to the business. This can make it difficult for the management of the business to operate efficiently. But a lease is not a loan and therefore may not require approval by the board for the managers to get the equipment they need. In smaller businesses this can also be an advantage because they will not show additional debt on the balance sheet that will affect their ability to borrow money in the future. If you are considering selling your business, this may also make your company more attractive to potential buyers since you will be showing less debt on your balance sheet.
Because we work with many leasing companies nationwide, we can help you determine if leasing your equipment is right for your business. If you should decide to lease, we can usually get the equipment you need with just a simple, one page credit application. In many cases we can have the new equipment on site in as little as a few days.
Points and Interest Rates:
Even the most experienced borrowers have difficulty understanding the relationship between the interest rate and the points or fees associated with their loans. The reality is that the two are directly related in that “points” are nothing more than interest that is charged up front. The actual rate and number of points a borrower pays is largely dictated by the quality of the borrowers credit. As the credit quality decreases, the interest rate, points and fees increase. This is because these loans are more difficult to fund and pose a greater risk of default to the lender.
Here are some issues to consider:
Often the price of a business loan is stated in terms of an interest rate, points and other fees. A point is a fee that equals 1 percent of the loan amount. Points are usually paid to the lender, mortgage broker, or both at the settlement or upon completion of the escrow. Often, you can pay fewer points in exchange for a higher interest rate or more points for a lower rate. Ask your finance specialist about points and other fees.
A document called the Truth in Lending Disclosure Statement will show you the Annual Percentage Rate (APR) and other payment information for the loan you have applied for. The APR takes into account not only the interest rate, but also the points, mortgage broker fees and certain other fees that are associated with your loan. Also, ask if your loan will have a charge or a fee for paying all or part of the loan before payment is due (prepayment penalty).
A lender may require you to obtain certain settlement services, such as a new survey, mortgage insurance or title insurance. It may also order and charge you for other settlement-related services, such as the appraisal or credit report. A lender may also charge other fees, such as fees for loan processing, document preparation, underwriting, flood certification, or an application fee. You may wish to ask for an estimate of fees and settlement costs before choosing a lender. Some lenders offer no cost or no point loans but normally cover these fees or costs by charging a higher interest rate.
If you see advertisements for lenders offering extremely low rates, don’t be misled. Most of the time these very low rates refer to the starting rate on an adjustable rate mortgage or graduated payment mortgage. In other cases, the rate advertised may be for a balloon loan. This is a loan where the remaining balance will have to be paid off early. An example of this is called a 30 due in 5. In this type of loan your payments are based on a 30-year term to make them affordable. The remaining balance of the loan however, must be paid off at the end of the 5th year. This means that you will probably have to refinance the loan or sell the business at the end of 5 years to satisfy the debt. Locking in your rate or point at the time of application or during the processing of your loan will keep the rate and/or points from changing until settlement or closing. Ask if there is a fee to lock-in the rate and whether the fee reduces the amount you have to pay for points. Find out how long the lock-in is good for, what happens if it expires, and whether the lock-in fee is refundable if your application is rejected.
Finding financing that you can live with for the next 30 years is serious business. Ask about alternative kinds of mortgages in your area. Compare rates, down payments, and closing costs among different types of lenders. Here is where a finance specialist can save you time and money. There is no single nationwide mortgage rate; interest rates can vary according to the amount of the mortgage, the length of the loan, and from lender to lender. Look at the entire package that’s being offered, including the fine print about penalties and assumptions. The more knowledgeable you are about the loan process, the fewer surprises will be in store for you at closing.