Equipment Lease vs. Finance: What's the Difference?
Equipment leasing and equipment finance differ mainly in terms of ownership. An equipment lease lets you rent business equipment from the vendor for a monthly payment, but you don’t own the equipment during the lease term. Equipment finance is a collateralized loan that allows you purchase a piece of equipment. Once you’ve repaid your loan according to its terms, you fully own your equipment.
From a small business owner’s perspective, many tools of the trade are considered equipment. These include computers, office furniture and fixtures, kitchen appliances, HVAC units, and company cars.
The cost for such specialized equipment can pile up, and it’s usually impossible to pay for everything, in full, using your own capital. That’s where an equipment lease vs. finance comes in. Equipment lease is similar to a rental agreement, and equipment finance falls into the category of business loans.
Both can help you acquire business equipment, but in different ways. We’ll show you those differences, and help you figure out which route makes the most sense for your business.
Equipment Lease vs. Finance: The Major Difference
As we mentioned, equipment leasing and equipment finance are two different ways to acquire equipment. Both give you immediate access to expensive equipment, but they’re structured in different ways. The primary difference has to do with ownership.
- Operating leases – This type of lease has low monthly payments and gives the business owner the option to own the equipment at the end of the lease term by paying its then-fair market value. Another name of operating lease is fair market value lease.
- Capital leases – This type of lease has higher monthly payments and is structured more like a loan. The difference is that the lease doesn’t appear on your balance sheet during the term of the lease. At the end of the lease, the business owner has the option to buy the equipment for a nominal price, like $1 or 10% of the purchase price. The $1 buyout lease and 10% option lease are popular examples.
With equipment leasing, you don’t own the equipment outright. Rather, a lender buys a piece of equipment from a vendor, and then rents it out to you for a monthly payment. At the end of your lease, you can choose to purchase the equipment, renew your lease, or return the equipment.
There are two main types of equipment leases: operating leases and capital leases. Here’s how they differ:
The size of your monthly payments and the benefits and drawbacks of equipment lease vs. finance will depend to a large extent on what type of equipment lease you have. Some capital leases are virtually indistinguishable from equipment finance.
If you opt for equipment financing, also called an equipment loan, your lender will front you the capital to pay for the purchase of a piece of equipment. Depending on what you’re buying, your equipment financing company can loan you all, or most, of the total value of your equipment. You’ll pay down your loan, plus interest, over time. Once you’ve repaid your loan according to its terms, you’ll fully own your equipment.
All told, an equipment lease lets you pay for the use of equipment for as long as the lease lasts, not necessarily for the ownership of that equipment. An equipment loan helps you pay for a piece of equipment outright. Like any other small business loan, though, you’ll need to repay your lender what you’ve borrowed, as well as interest. You can kind of think of an equipment lease as renting out an apartment, and an equipment loan as buying a house.
The difference between an equipment lease vs. loan doesn’t end there, though. Here are a few more key details about each financing product.
Equipment Leasing Pros and Cons
If you think that the equipment you need will become outdated in a few years’ time, then there’s no need to buy it. Instead, you can opt for equipment leasing, which allows you use of that conveyor belt, slushie machine, or computer, for a predetermined amount of time. Typically, equipment leasing agreements typically last between two and seven years, but it won’t outlast the equipment’s value.
Equipment Leasing Pros
No Down Payment or Collateral
If you’re looking to finance a piece of expensive equipment, there are lots of reasons to consider equipment leasing. First off, an equipment lease generally requires no money down, and no additional collateral to secure. That means you can keep a good chunk of your cash to contribute to your business’s other expenses, and you don’t need to risk any of your business or personal assets to secure this rental agreement.
Easy Application Process
The equipment leasing application process is fairly simple, too—you likely won’t need to provide as much financial paperwork as you would if you applied for a traditional small business loan. Plus, equipment financing for bad credit is available for applicants with challenged credit.
Repairs are the Lessor’s Responsibility
When you take out an equipment loan for a piece of equipment, you take full responsibility for it during the loan term. If the equipment breaks down or requires a repair, you’re responsible for fixing it. But with a lease, the leasing company will take care of any repairs. This is similar to apartment living, where the landlord presumably handles repairs for tenants.
Most lease agreements include several options after the lease ends. You can choose to:
- Purchase the piece of equipment. If you choose to buy the equipment you’ve been renting, the lender releases the title to the equipment to you
- Continue to lease the same piece of equipment
- Return the equipment
- Trade in your current equipment for a new or updated piece of equipment (and start a new lease for the new equipment)
That last point is one of the major advantages of equipment leasing. Ultimately, you’re under no obligation to hold onto the equipment you’re renting, since you don’t actually hold the title to that piece of equipment. If you’ve found that whatever you’ve been renting—say, a computer or a medical device—has become outdated equipment over the course of your lease agreement, you can easily return it. Then, the equipment leasing company can finance a newer model for you.
Equipment Leasing Cons
The biggest disadvantage of an equipment lease is price. Since a lease isn’t a loan, you won’t pay interest on your monthly payments. However, lenders offering equipment leasing will bake an effective interest rate into those flat monthly payments; it’s how the lender makes money off their deals.
The price of your equipment leasing deal will depend on a few factors in your application, like your personal credit score, your business’s annual revenue, and its age. For the most part, though, lenders determine the cost of based on the value of the equipment they’re buying, how well or poorly that equipment holds value, and the length of the lease.
Depending on where the lender prices your monthly payment, you might end up paying significantly more over the course of your equipment lease than you would if you’d taken out an equipment loan.
Equipment Finance Pros and Cons
Unlike an equipment lease, equipment finance is a loan that helps small business owners pay for a piece of equipment over time. Equipment finance is best for durable pieces of equipment that retain their value over a long period of time—such as tractors, trucks, and furniture. If your lender approves your equipment loan application, they’ll front you 80% to 100% of the cash you need to buy your equipment.
Then, you’ll repay that loan amount, plus interest, over a predetermined amount of time. The length of your equipment loan mostly depends on how long your lender anticipates that the equipment you’re buying will be valuable. Once you’ve paid off your loan, you’ll fully own that piece of equipment.
Equipment Finance Pros
Easy to Qualify
Equipment loans are generally easier to qualify for than traditional term loans, and most equipment lenders are happy to consider business owners with challenged credit. That’s because equipment loans are self-collateralized—if a borrower defaults on their loan payments, then the lender can seize the equipment they’re financing, and liquidate it, to retrieve their lost money.
That built-in safety net lessens the lender’s risk of losing everything if the borrower defaults. For that reason, equipment lenders are a bit less strict about things like a business’s average annual revenue, age, and the business owner’s personal creditworthiness during their vetting process.
When considering a loan candidate, equipment financing companies are mainly concerned with the condition and resale value of the equipment they’re financing. The better the condition and the higher the resale value, the lower the interest rate. The equipment’s resale value determines how much money a lender is willing to extend you—where, you guessed it, the higher the resale value, the more money they’re willing to loan you.
No Collateral Needed
Since equipment loans are self-secured, your equipment loan agreement probably won’t ask you to offer up any additional collateral to secure your loan.
Relatively Low Cost
Like any other loan, you’ll need to pay interest on an equipment loan in addition to the principal amount of the loan. Business loan interest rates for equipment financing can be as low as 8%, but they may also shoot as high at 30%. Even at the higher end, that’s lower than the interest rates charged on ordinary short-term loans. Usually, the long-term cost of an equipment loan is lower than a lease.
Equipment Finance Cons
Down Payment Might be Required
If you’re approved for an equipment loan, your lender might front you 100% of the cost of your equipment, but this isn’t usually the case. Often, lenders supply around 80% of the amount of the equipment, which means it’s your responsibility to pay for the remainder upfront.
The good news, though, is that the bigger down payment you can bring to the table, the better your chances are of scoring a lower interest rate on your loan.
You’re Stuck With the Equipment
Before you apply for a loan to buy a specific piece of equipment, be sure that it’ll retain its value by the end of your loan’s terms. Otherwise, you’ll be tied to an outdated tool that you might need to pay to replace.
Equipment Lease vs. Finance: Which is Right for Your Business?
If you’re itching for a new piece of equipment stat, but you’re fresh out of funds to pay for it upfront, don’t worry! You have options. The key is deciding between an equipment lease vs. loan.
To help you decide, consider these two factors: how much money you have available right now; and how quickly the equipment you’re eyeing will become outdated.
If you have the money for a down payment, and the piece of equipment you intend to finance will last your business a long time, then an equipment loan might be the way to go. But if you have little money to put down, or the piece of equipment you intend to finance will quickly become obsolete, then you might want to consider an equipment lease instead.
If you’re still confused, try an equipment lease vs. finance calculator, like this one from CalcXML.
Keep in mind that both equipment loans and equipment leasing can offer tax incentives, too. As you’re well aware, taxes can get tricky, so speak with an accounting professional if you have questions about which option is right for you from a tax perspective.
Caroline Goldstein is a contributing writer for Fundera.
Caroline is a freelance writer and editor, specializing in small business and finance. She has covered topics such as lending, credit cards, marketing, and starting a business for Fundera. Her work has appeared in JPMorgan Chase, Prevention, Refinery29, Bustle, Men’s Health, and more.