Types of equipment lease financing
Although lessors may have different names for them, you'll find that there are basically two types of equipment lease financing: finance and true.
Also known as capital leases, conditional sales, or dollar buy out leases, these leases work best if you intend to keep the equipment at the end of the lease. The main advantage of this type of lease is that it gives you the option to purchase the equipment for a nominal fee, usually $1.00. Payment terms on finance leases tend to last close to the expected useful life of the equipment.
On the other hand, true leases, also called tax leases, operating leases, or FMV (fair market value) leases, do not usually span the full expected life of the equipment. At the end of the lease, you can choose to walk away from the equipment or purchase it at fair market value. Payments on true leases generally tend to be lower than those on finance leases. This is because lessors have the opportunity to resell the equipment when the lease ends.
One of the main benefits of true leases is that you may be able to fully claim lease payments for tax purposes. In contrast, the IRS considers finance leases little more than installment purchase plans. As a result, although finance leases let you spread your payments over time, they are not tax advantaged in the way true leases are.
Again, it's important to discuss the tax implications of your equipment lease financing with an accountant before signing any contract.
While fixed monthly payments are the norm, they are not your only option. Depending on your company's financial situation, your equipment lease financing can include one of several payment plans that may be more appealing.
If your company's cash flow ebbs and flows with the seasons, you might want to consider a skip lease. A lease with this repayment structure allows you to skip payments during slow months without being penalized. They are ideal for recreational and agricultural businesses that rely heavily on certain times of the year for significant portions of their revenue.
Step-up leases provide a solution for companies with limited cash that are depending upon the acquisition of specific equipment to increase revenue. This type of lease recognizes that the company will be able to handle increased lease payments over time, and keeps payments low at first then ramps them up according to a pre-determined schedule.
An alternative to a step-up lease is a 60- or 90- day deferred lease. Just as its name implies, this lease allows you to defer your first payment for 2 or 3 months. Usually you will not have to present a down payment with this option.
Ending your lease
Lease terms range anywhere from 6 to 120 months, although the majority fall between 12 and 60 months.
The lease term that you decide upon will depend heavily on what you decide to do with the equipment at the end of your lease. Usually, you have four choices. You can:
- return the equipment to the lessor with no future obligation
- renew the lease
- purchase the equipment for a nominal fee or fixed price agreed upon at the lease inception
- purchase the equipment at fair market value
Before agreeing to any particular end of lease clause, carefully consider what state the equipment will be in at the end of the lease, and whether you'll want to obtain a newer model at that time. Also consider the chances that you'll want to get out of the lease early - if you think it's likely, be sure that your lease doesn't contain substantial penalty clauses for early withdrawal.