What Is Equipment Leasing?
Equipment leasing is a form of financing that allows business owners to rent equipment—such as machinery, vehicles, computers, and more—from a vendor or leasing company for a specific period of time. At the end of the lease, the business owner must return the equipment, renew the lease, or purchase the equipment.
Overall, equipment leasing is typically more expensive in the long-term than purchasing or traditionally financing the equipment, but it can mean lower monthly payments for the business.
Is equipment leasing right for your business? We’re here to help—in this guide, we’ll break down everything you need to know to determine if equipment leasing is a suitable financing solution for your small business.
How Does Equipment Leasing Work?
With a traditional business loan, you receive capital from a lender and repay that debt, with interest, over time.
Similarly, with equipment financing, you receive capital specifically for the purpose of purchasing a piece of equipment—you use that capital to purchase the equipment and then repay the loan, with interest, over time. In this scenario, you own the piece of equipment you’ve purchased.
Equipment leasing, however, works differently. With equipment leasing, a lender, financing company, or vendor lets you rent the equipment you need for a specific period of time—instead of buying it or seeking financing for it.
You make monthly payments for a predetermined number of months, and once the lease ends, you can choose to renew your lease, buy the equipment, or end the lease and return the equipment.
Rates and Terms
Although you won’t pay interest on an equipment lease in the same way as you would on a traditional loan, leasing companies typically calculate interest automatically into your monthly payments—and therefore, leasing is often considered more expensive in comparison to equipment financing in the long run.
In general, you can expect to see rates on equipment leasing to range between 5% to 35%. Plus, on top of your monthly payments, you may also face additional costs for insurance payments, maintenance and repairs, as well as other fees associated with the leasing process.
You’ll also find that terms, or repayment periods will vary as well, but tend to range from one to six years.
Types of Equipment Leasing
With this understanding of how equipment leasing works, let’s look at the two main types of equipment leases:
- Capital lease: A capital lease is an equipment lease where you can put the leased equipment on your balance sheet—equivalent to how it would appear if you owned the equipment outright. Monthly payments tend to be higher with capital leases, similar to an equipment loan. With this type of lease, you’re more likely to buy the equipment at the end of the lease term.
- Operating lease/fair market value lease: With this type of equipment lease, you don’t receive the benefits of ownership, but monthly payments tend to be lower. This type of lease works well with computers and other equipment that needs to be upgraded frequently. In this case, you’ll likely return the equipment or renew the lease at the end of the term.
Even within capital and operating leases, however, there are other types of equipment leases as well. For example, a $1 buyout lease is a common type of capital lease—in which the lease holder (i.e. business owner) can purchase the equipment at the end of the lease for the nominal price of $1.
Similarly, a $10 option lease allows the business owner to purchase the equipment at 10% of the equipment’s original value.
In any case, with the different types of equipment leases, you’ll want to think about your eventual goals—if your goal is to sustain low monthly payments, an operating lease is likely better for your business. On the other hand, if your goal is to buy equipment down the line, a capital lease will be better for your needs.
Pros and Cons of Equipment Leasing
Like all forms of debt financing, equipment leasing has both benefits and drawbacks.
Let’s review some of the points you’ll want to consider to determine if leasing is the right solution for your business.
- Allows you to change out your equipment regularly: Although it’s entirely impractical for most businesses to buy new equipment every year or two, short-term leasing will usually allow you to equip your company with the latest hardware or machinery. If you’re looking for electronic or medical equipment, for example, a lease can often be the best choice for your business.
- Can test out or try equipment for short periods of time: If you plan to keep the equipment for at least five years, purchasing or securing a loan is probably the better option. But if you don’t need the equipment for the long haul or you’re unsure whether it’s the right piece of equipment for your needs, it makes sense to lease it.
- Lower monthly payments: Equipment leasing has lower monthly expenses than if you were purchasing equipment with a loan or line of credit. Therefore, leasing is often the best option for business owners who don’t have the cash to buy their new equipment outright.
- Fixed interest rate instead of a floating rate: If you’re choosing between equipment leasing vs. equipment financing, keep in mind that equipment leasing offers more flexibility when it comes to interest rates. Rather than a floating rate, standard with bank loans, leasing equipment gives you a fixed rate for the term of the lease. In addition, leasing provides 100% financing—which means that it can extend to “soft costs” like training, sales tax, and installation.
- No down payment or collateral required: Although there’s some variation, equipment leasing does not generally require a down payment or collateral. In fact, you’ll find that many equipment leasing companies offer simple and fast application processes.
- Offers the opportunity for tax incentives: Leasing equipment comes with some fairly serious built-in financial advantages—tax credits. Under Section 179 of the IRS tax code, leasing is often entirely tax deductible. The maximum annual business tax deduction is currently set at just over $1 million, and business owners can deduct up to 100% of many leasing expenses, provided that they meet certain terms and don’t exceed the maximum cap.
- More expensive in the long run: Although equipment leasing offers lower monthly payments, it will almost always be more expensive in the long run than equipment financing or purchasing equipment outright—especially if you opt to purchase the equipment at the end of the lease.
- You have no equipment at the end of the lease: Provided that you still need the piece of equipment at the conclusion of your lease, you have a decision to make—you either have to buy your equipment, opt for a new lease, or make some sort of other arrangement—as opposed to simply owning your equipment as you would at the conclusion of your loan payments.
- Can’t consider the piece of equipment an asset: Depending on the equipment lease you have, you lose the benefit of being able to consider the piece of equipment an asset—which can make a difference when you’re applying for a business loan or evaluating the value of your business.
- Enforced term lengths or costs: In some cases, an equipment leasing company may require a specific term length or similarly, require that you cover specific upgrades. Unfortunately, this can result in situations where you’re paying for a piece of equipment you no longer need or use until your term ends.
How to Apply for Equipment Leasing
At this point, if you think that equipment leasing might be right for your business, you’re likely wondering how to apply.
The process will vary based on the vendor, company, or business lender you work with, but in general you can expect to follow these six simple steps:
1. Research the equipment you’re looking to lease.
First and foremost, you’ll want to make sure that you thoroughly research the piece of equipment you’re looking to lease. You should have a good idea of how much the piece of equipment costs, what maintenance it will need, and you may even get quotes from a few different vendors ahead of time.
During the application process, you’ll need to discuss this information with different equipment leasing companies, so it’s helpful to have this step completed before you even begin applying.
2. Evaluate your business’s qualifications.
Just like any other form of debt-based financing, the equipment leasing company you work with is going to evaluate your business credentials before deciding whether or not to work with you. That said, it’s important to get a sense of where you stand before exploring your options and filling out applications.
Although lenders and equipment financing companies will each have their own requirements, in general, you’ll want to think about your personal credit score, time in business, and annual revenue—as these are three of the most common qualifications used to evaluate your business’s eligibility.
3. Compare top equipment leasing companies.
Next, you’ll want to research equipment leasing companies. A variety of financial institutions offer equipment leasing—including banks and online lenders. In addition, some equipment manufacturers and dealers themselves even offer equipment leasing.
With this in mind, it’s important to find an equipment lessor that is both reputable and offers a leasing program that you can qualify for. As you’re comparing different providers, it can be helpful to review their website, talk to representatives, and read online reviews from previous customers.
If you’re looking for a place to start, consider these options:
4. Gather your documents and submit your application.
Once you’ve decided which equipment leasing company (or companies) you’d like to apply to, you’re ready to gather your information and start your application. Each lender or company will have a unique application process—but most will offer an online-based, streamlined application system.
In general, you can expect to provide basic information about yourself and your business, as well as any other business owners. You may also be asked for documentation such as bank statements, tax returns, financial statements, and an equipment quote.
5. Receive approval and review the lease.
After you’ve submitted your equipment leasing application, hopefully you’ll receive approval from the lender or leasing company. At this point, you should receive a draft of the leasing agreement for your review.
Before signing, you should ask any questions you have, make sure you understand the terms, fees, payment system—and, of course, compare multiple offers if you have them. In addition, you might ask a business attorney to review the lease with you as well.
6. Sign the lease and receive your funds.
Once you’ve reviewed the lease, it’s time to sign the agreement and pass it back on to the equipment leasing company. They’ll work through the closing process and notify you once the lease is in effect.
Then, depending on the terms of your lease, they’ll either transfer you the funds or send them directly to the manufacturer for the purchase of your equipment.
Frequently Asked Questions
Q: What is an equipment lease?
A: An equipment lease is an agreement in which the owner of the equipment, the lessor, allows a third-party, the lessee, to use the equipment in exchange for scheduled payments. In other words, an equipment lease is a rental agreement between the lessor and the lessee.
Q: Is leasing equipment better than buying?
A: Leasing equipment can be better than buying if you want:
- Lower monthly payments
- To free up cash flow with predictable payments
- To avoid getting stuck with outdated equipment at the end of a loan
- To be able to upgrade or switch out equipment frequently
Ultimately, however, there are pros and cons to both leasing and buying equipment and which is better will vary based on the individual business.
Q: Are equipment lease payments tax deductible?
A: Yes. In general, equipment lease payments qualify for the Section 179 deduction. In fact, many business owners can deduct up to 100% of leasing expenses, provided that they meet specific terms and don’t exceed the maximum deduction.
A tax professional can work with you to determine whether or not your equipment lease payments qualify for tax deductions.
However, if you’re still unsure, it’s important to remember that equipment leasing isn’t the only financing option out there. In addition to equipment financing, there are a variety of types of business loans that might also be worth considering.
- Section179.org. “FAQs”
Randa Kriss is a senior staff writer at Fundera.
At Fundera, Randa specializes in reviewing small business products, software, and services. Randa has written hundreds of reviews across a wide swath of business topics including ecommerce, merchant services, accounting, credit cards, bank accounts, loan products, and payroll and human resources solutions.