Equipment Finance 101

Lease/Loan Comparison

Payment Terms

Lease

Leases involve the payment of rent for the use of an asset over a specific period of time.

Loan

Borrower repays advance of funds with interest that is stated or clearly calculable over a specific period of time.

Terms of Ownership of Equipment

Lease

Lessor generally holds legal title to the equipment. Lessee may have a right to purchase the equipment at the end of the lease or during the lease term.

In a true tax lease, the lessor generally retains significant residual value risk and upside opportunity. As such, the lessor generally also retains tax benefits, usually depreciation, which usually reduces the rent payment below the cash debt payment of found in a conditional sales contract. The lessee may return the equipment at the end of the lease term.

A lease with a Fair Market Value purchase option allows the lessee to return the equipment without further obligation when the lease ends or purchase the equipment at its fair market value or other agreed price.

Loan

Borrower holds legal title to the equipment.

Lender has no expectation of return of the equipment and except in certain structured circumstances, has no residual value at risk at the end of the term of the conditional sale transaction. The borrower retains the risk of ownership of the asset at all times.

A loan does not alter borrower's full ownership of the equipment at the end of the loan term in the absence of any default.

Down Payment Requirements

Lease

None. A lease generally finances 100 percent of the value of the equipment. Initial lease payments at the beginning of the first payment period are usually much lower than the down payment. Some leases may include initial rent holidays (periods with no rents due).

Loan

An equipment loan usually requires a down-payment and finances the remaining cost of the equipment.

Payment Scheduling

Lease

Lease payments may be made in advance or in arrears of each leasing period and often are structured to start low and increase later in the lease.

Loan

Loan payments are generally made in arrears of each loan period.

Collateral Requirements

Lease

Leased equipment usually serves as the collateral needed to secure the transaction. The lessor's recourse is generally limited to repossessing the equipment.

Loan

Depending on the credit worthiness of the customer, a business loan may require the customer to pledge other current assets (deposits) or fixed assets for collateral. A non-recourse loan limits the lender’s recourse to the borrower due to non-payment, however is secured by the equipment and related cash flows, insurance and certain indemnity payments. Therefore equipment can be seized in event of default.

Tax Treatment

Lease

In a true tax lease, the lessee (end user) claims the lease payment as a tax deduction. The deduction is generally based on when the payments are due. For a level rent payment, this simplifies budgeting.

Equipment financed under a conditional sale lease or lease with a $1 purchase option is treated the same as owned equipment by the lessee.

The lessor claims tax depreciation which is often accelerated, resulting in larger tax deductions in the early years. Lessors pass this benefit to the lessee in the form of lower rents compared to a loan.

Lessors generally bear the risk of changes in tax laws (i.e. if the tax rates increase).

Loan

Borrowers/owners may claim a tax deduction for a portion of the loan payment as interest and for depreciation which is tied to IRS depreciation schedules.

Borrowers bear the risk of changes in tax laws.

Obsolescence Risk

Lease

The risk of equipment obsolescence is borne by the lessor, since the lease is often priced assuming a future value of the equipment at the end of the lease (residual value risk) and the equipment is often returned at the end of the lease.

Loan

Some leases contain provisions for upgrading equipment during the lease term for additional rent. The borrower/owner bears the risk of equipment obsolescence and devaluation, due to development of new technology. The owner is responsible to remarket the asset at the end of its useful life.

Assets Eligible to Borrow Against/Finance

Lease

Leases tend to finance items of equipment, software and services. Leases tend to finance assets which are periodically replaced with newer assets.

A "Master Lease" acts as an umbrella for the financing of multiple deliveries of equipment represented and documented by schedules to the Master Lease.

Loan

Loans can be used to pay for a broad array of capital needs, including sales finance, inventory finance and business expansion.

Inflation Impact

Lease

More of the cash flow, especially the option to purchase the equipment, occurs later in the lease term when inflation generally makes future dollars cheaper.

Loan

A larger portion of the financial obligation is paid in today's more expensive dollars.

Also see, Lease or Loan? What You Need to Know to Decide