Looking to finance or lease some new equipment? You might as well be looking at a buffet menu. There is no shortage of choices when it comes to financing heavy equipment. So how do you decide what’s right? That’s exactly what we plan to cover in our blog, and we’ll start this one off with one of the more common types of financing to fund your new equipment needs– the ever-popular lease.
Why Are Leases so Common for Heavy Equipment?
Because every business that relies heavily on the use of equipment needs to keep up with technological changes to stay competitive. Whether your company deals with technology, healthcare, or a substantial reliance on heavy equipment; newer equipment often gives you the edge to get the job done faster.
Speed is the name of the game in most industries, and the faster you can get the job done, the better off you’ll be.For that reason, equipment leases have become very popular. They are often faster to get approved and have less red tape. They also have some unique benefits which we’ll get into in these next two blog posts.
There are 5 common types of equipment leases, and in the interest of keeping things succinct, we’ll cover the first two very common equipment leases in this blog:
- $1 Buyout Lease
- Fair Market Value Lease
Let’s dive into the explanations, pros, & cons of each.
Explanation of a Dollar Buyout Lease
This type of lease offers a $1 buyout at the end of the lease term; it is often called a capital lease or a finance lease because it is more similar to a loan than a typical lease. With a dollar buyout lease, after the lease period ends, you will typically have the option to buy the equipment and obtain full ownership for only $1.00.
Explanation of a Fair Market Value Lease
With a fair market value lease, you can opt for a lease that provides lower monthly payments and an opportunity to purchase the equipment at the end at a full fair market value. It also provides a mechanism for companies to avoid being saddled with outdated equipment after the lease comes to an end.
In most cases, you’ll have a lower monthly payment with a fair market value lease than with a capital lease, an equipment finance agreement, or a loan. The finance company usually expects to do a renewal lease or sell the equipment to the lessee at the end of a fair market value lease. Of course, you still have the option to purchase the equipment for the fair market value after the lease term expires or simply return the equipment.
Pros and Cons of a $1 Buyout Lease
There are significant advantages and disadvantages when considering this type of lease. Here are some of the top reasons why a $1 buyout lease may be a good fit for your company:
- Financing with very little money down – If you don’t have the capital to make a down payment, but you expect ongoing revenues to pay the monthly bill, a $1 buyout agreement could get you the equipment you need without a huge upfront cost.
- Quick access to heavy equipment – Delay could make all the difference when bidding on a major job.
- Ownership of equipment after the lease – If your company wants to expand its equipment ownership, a $1 lease offers a convenient path to finance a purchase.
- Tax advantages – This type of lease allows you to claim depreciation costs as a business expense when filing your taxes. This reduces your taxable income and is a major reason why even established companies opt for this type of big-ticket financing.
On the other hand, there are also many reasons for companies to opt for a different type of financing. Here are three major reasons:
- Higher monthly payments – In most cases, a $1 buyout option will have higher monthly payments than a traditional lease.
- Debt on the balance sheet – If your company wants to limit the debt on your balance sheet, a $1 buyout may not be for you. Because this type of lease is more like a loan, it shows up as debt on your company’s financial reports.
Pros and Cons of a Fair Market Value Lease
There are some major benefits of a fair market lease, starting with costs. Here are some reasons to consider this option:
- Lower monthly payments – In general, lease payments are much lower without the $1 buyout option and lower than loan payments.
- Relatively easy approval – Like with a $1 buyout, it is often easier to qualify for a lease than a loan. This type of lease may be even easier to qualify for, making it an appealing choice for newer or smaller companies.
- Choosing whether you want the equipment – You can buy the equipment at the end of the lease if you want it, but you may opt for a different lease for newer technology. You won’t be saddled with outdated equipment.
- Tax advantages – While you cannot deduct depreciation with a fair market lease, you can deduct your payments as an operating expense, so there are also significant tax advantages of this type of lease.
As with a dollar buyout lease, there are also reasons why a fair market value lease may not be the right choice for your company, including the following:
- Overpriced buyout prices – Finance companies may offer valuations that exceed a truly fair market value to buy the equipment at the end of the lease term. Make sure you have an agreement on the front end (before you sign the dotted line) for how the fair market value will be established at the end of the lease term.
- Auto-Renewal Awareness – Most leases come with an auto-renewal clause, which can be easy for companies to miss. You could wind up trapped with another lease cycle if you are not careful. As a general rule of thumb, you should contact your financing company 7-8 months prior to the end of your lease agreement to make sure you begin the negotiations for a fair market value price or to end your lease on the termination date.
In conclusion, you can think of a fair market value lease as an option to use the equipment you need without being “married” to it (unless you want to be, after you “date” for a while), while a capital lease with a $1 buyout is a route towards purchasing the equipment with little to no upfront capital (and you are definitely married to that equipment).
These are just two of your leasing options, although very popular, that could help your company get the equipment you need. We’ll go more in-depth on the other three on the next blog.
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