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Would you like to lease equipment for your small business? You're in luck! Leasing can help you get the equipment you need without breaking the bank. You should know what types of leases are available before signing on the dotted line. Each type of equipment lease has benefits and drawbacks based on tax concerns, monthly cash flow considerations, and ownership options at the end of the lease.
Here are five of the most common types of leases:
The $1 buyout lease is similar to an equipment loan. During the lease, the borrower makes payments to rent the equipment and then can purchase it for $1 at the end of the lease. Payments for the lease are the largest of all the lease types. Both the asset leased and the liability will appear on your balance sheet.
With this type of lease, interest rates will be the lowest. When you want to own the equipment at the end of the lease, use this type. Borrowers who choose this option can spread out the cost of the equipment over their term, rather than having a large lump sum at the end of the loan.
In the same way as a $1 buyout lease, a 10% option lease allows the borrower to make payments and has the option to purchase the equipment at the end of the lease for 10% of its initial value. A 10% option lease can be used to obtain ownership of leased equipment, however the borrower can also walk away at the end of their lease, foregoing the 10% payment and returning the leased equipment. If a business isn't sure whether it will purchase the equipment at the end of the loan, this type of loan is a good option.
During a fair market value (FMV) lease, the borrower makes monthly payments and uses the equipment throughout the lease, and can purchase it at the end of the lease for fair market value. At the conclusion of the lease, borrowers may choose to renew the lease or return the equipment.
In contrast to the first two types of leases, the borrower does not gain any benefits or disadvantages from being an owner. This also means that only monthly payments are deductible from the lessee's taxes. Typically, these leases are the most difficult to qualify for, requiring good credit scores and high annual revenue, and usually, the equipment leased must have a high value.
A borrower who plans to buy the equipment at the end of the lease should avoid this lease type. Because the lessor assumes more risk because it is more likely that he or she will have to find another renter for the equipment, the interest rate may be higher than the $1 buyout or the 10% option.
Businesses that acquire equipment that they know they will replace at the end of the term or have a short shelf life are best off using a FMV lease.
One significant difference between 10% option leases and 10% purchase upon termination (PUT) leases is that in the 10% PUT lease, the borrower does not have the option to walk away. This reduces the risk for the lessor since the lessee must buy the equipment at the end of the lease. As a result, borrowers with bad credit will be able to qualify for 10% PUT more easily.
Leases of this type are best suited to businesses that are looking to purchase equipment after the lease term has expired, but need to make a smaller payment than the $1 buyout or 10% option leases.
Terminal rental adjustment clause (TRAC) leases are commonly used for semi-trucks and other vehicles. This is either a capital lease or an operating lease. Due to this lease's flexibility, the lessee can set up a high balloon payment at the end of the lease, making it ideal for truck or vehicle loans. As a result of the higher balloon payment at the end, the monthly payments are lower throughout the lease.
Due to the high balloon at the end, borrowers should have strong credit profiles. A lease of this type is used when a lessee doesn't want to own the asset at the end of the lease, usually because they want to upgrade to a newer model.
A lot of equipment leases are similar to equipment loans. It is important to note that equipment loans always result in a transfer of ownership at the end of the loan. Leasing offers flexibility to businesses looking to upgrade equipment at the end of a repayment period. There are some instances in which lessees can walk away from a balloon payment at the end of a lease, resulting in lower monthly payments than loans without ownership requirements.
When choosing between a lease and a loan, businesses should consider these factors:
There are many factors to consider when deciding whether to get an equipment lease versus an equipment loan. Whenever possible, consult a tax professional regarding large capital expenditures. Leasing makes sense in many cases, especially if a company intends to upgrade its equipment at the end of the lease or if it needs lower payments through leases with balloon payments. A $1 buyout lease or a 10% put lease makes the most sense for a business leasing equipment with the intention of gaining ownership at the end.
