Equipment financing: lease or buy

A new oven, a truck, a machine that doubles output. When a business needs equipment, there are three common ways to pay for it over time: an equipment loan, a lease that ends with you owning it, or a lease where you hand it back. Each spreads the cost differently, and the cheapest monthly payment isn’t always the cheapest overall.

The options

An equipment loan works like a term loan secured by the equipment. You own it from day one, usually after a down payment, and the lender can take it back if you don’t pay.

A finance lease (sometimes called a capital lease or $1 buyout lease) lets you use the equipment for a set term, then buy it for a nominal amount. Economically, it’s close to buying with a loan.

A fair market value lease (often called an operating lease) has lower payments. At the end, you return the equipment, renew the lease or buy it at its market value then.

For equipment you need only for a single job or a season, renting may beat all three. Rental costs more per month, but there’s nothing to finance, maintain or sell later.

An illustrative cost comparison

These figures are made up to show how the math works. They are not offers, and real quotes depend on your credit, the equipment and the lender. Say a business needs a $60,000 machine it expects to use for about seven years.

In this illustration, leasing costs less over five years if you hand the machine back, and slightly more if you buy it at the end. If the machine will still be productive in year seven, owning it usually wins. If you’d want the newer model in three years anyway, the lease’s lower payments and easy upgrade may be worth more.

New or used

Used equipment costs less upfront, but some lenders offer shorter terms or higher rates on it because it’s worth less as collateral and may need repairs sooner. If you’re comparing a new and a used machine, compare the total cost over the years you expect to use each, including maintenance and downtime, not just the price or the monthly payment.

What lenders look at

Because the equipment secures the loan, equipment financing can be easier to qualify for than an unsecured business loan. Lenders still look at time in business, revenue, the owner’s credit and the type of equipment. Equipment that holds its value and is easy to resell, such as trucks or standard machinery, tends to get better terms than custom or fast-changing technology. Expect to provide a quote or invoice from the seller, recent bank statements and sometimes tax returns.

Taxes: what to ask your accountant

Tax treatment can change which option costs less, so it’s worth a conversation with a tax professional before you sign. This guide isn’t tax advice, but here are the questions to ask, based on IRS guidance:

• Depreciation: if you buy the equipment (with cash or a loan), you generally recover its cost through depreciation. IRS Publication 946 explains how.
• Section 179: businesses can elect to deduct the cost of qualifying equipment in the year it’s placed in service, up to an annual limit that changes over time. The election is made on Form 4562.
• Bonus depreciation: an additional first-year allowance may apply to some property. Rules and percentages have changed in recent years.
• Lease payments: payments under a true lease are usually deducted as a business expense; a finance lease may be treated as a purchase.
• Interest: interest on an equipment loan is generally a business expense, subject to limits.

Questions to ask any lender or lessor

1. What’s the APR on the loan, or the total of all lease payments?
2. What are my options at the end of the lease, and how is market value set?
3. Who pays for maintenance, repairs and insurance?
4. What happens if I need to end the agreement early?
5. Are there documentation fees or a security deposit?
6. Will you file a lien on the equipment or on other business assets?

Other routes

Some manufacturers and dealers offer their own financing, sometimes with promotional rates. For large, long-life equipment or premises, an SBA 504 loan can offer long fixed-rate terms through a certified development company, though it takes weeks to arrange. See our SBA programs comparison for details.