Equipment Leasing: Buyer Beware
by Dick Leask, President, Belvedere Equipment Finance
Eight out of ten companies lease equipment because leases are readily available, simple and fast. Most equipment vendors offer leasing, as do many independent leasing companies. For equipment purchases under $75,000, financial statements for your company typically are not required and the lease is generally approved within a day. It all sounds good; the problem is that it can be very expensive. Interest rates on such deals are often over 10% and sometimes over 20%.
Youíll probably find that leasing companies donít like talking about interest rates. They typically quote a monthly payment rather than an interest rate Ė and for good reason. A $1,100 payment on $50,000 in equipment sounds a lot more reasonable than a 15% interest rate. You can ask the leasing company to quote the interest rate, but they may be unwilling to provide the rate, or if they do, it may be understated. Unless you have a financial calculator, you canít figure out the interest rate yourself.
In addition, even if you are able to calculate the interest rate, leases frequently include gimmicks that increase the actual interest rate significantly without your realizing it.
How leasing companies increase the rate:
Advance rentals. The interest on an equipment loan is calculated based on payments being made at the end of each month. The catch is that payments on leases are due on the first of the month and the first and last lease payments are usually payable at the start of the lease. Collecting first and last payments in advance increases the interest rate by 0.75% on a 36-month lease. Sometimes leasing companies collect the first and last payments when the lease is signed rather than when the equipment is delivered which further increases the rate.
Interim rent. Leasing companies charge interim rent from the date the equipment is delivered until the first of the next month when the monthly payments start. It is reasonable to charge interest from the date the equipment is delivered until the date that the first payment is due, but interim rent is calculated by pro-rating the monthly payment - substantially more than the interest. For example, interim interest on a $100,000 lease with monthly payments of $3,000 might be $300, but interim rent for the same period would be $1,500. That difference increases the actual interest rate by about 2% on a 36-month lease.
Purchase Option. Leases include a purchase option at the end of the lease Ė typically $1 or 10% of equipment price. Your right to acquire the equipment at the end of the lease may be contingent on giving written notice during a short window period several months before the end of the lease. If you donít give notice (chances are good that you wonít remember to do so), the lease automatically extends for a year. On a three-year lease, the interest rate increases from 6% to 20% if the lease is extended for a year. Computer companies sometimes offer a lease with a zero interest rate, but that rate doesnít include the cost of buying the equipment at the end of the lease. If you buy the equipment, the actual interest rate can jump from 0% to 20%.
The bottom line is that a lease from a leasing company can be a whole lot more expensive than a bank loan Ė and sometimes more expensive than using a credit card. A good rule of thumb is that the smaller the lease, the higher the interest rate. The interest rate for a lease on less than $100,000 in equipment is likely to be over 10% and can be more than 20%.
How to avoid being stuck with an expensive lease. If you are considering a lease, make sure you know the real cost. Ask your CPA to calculate the interest rate and be sure that they consider advance rentals, interim rent, and residual values when they do the calculation.
Better yet, donít wait until you need equipment. Plan ahead. Ask your bank to include an equipment financing commitment when you renew your line of credit. That way you will have financing available when you need it, and at an attractive rate.
Equipment finance doesnít have to be expensive. Awareness of the potential pitfalls and advance planning can save you a lot of money.