Lease vs Bank

WHY NOT JUST GO TO THE BANK?

Ownership Versus Use

When considering whether to lease or buy equipment, remember that there is a difference between ownership of equipment and the use of equipment from the perspective of profit generation.

 The only time that ownership of an asset earns profit is when that asset appreciates in value - like real estate, patent rights, precious metals or collectibles.  If it is an appreciating asset, it makes sense to own it.  If it is not an appreciating asset, then what you really want to do is gain the use of it for the time that you are going to need it. 

 Another factor mitigating against ownership is that new technology is obsolescing everything that was “new technology” a couple of years ago, and that is something that is going to continue to happen in the future... only faster.  So, given that most equipment is going to be worth very little very soon, ownership becomes even less desirable.

 Rates

Banks charge lower interest rates than leasing companies most of the time, don’t they?  Well, not exactly.  That’s because rate per se, the cost per thousand dollars of equipment per month or the “interest rate” that is being factored into the transaction, is an unimportant consideration.  What are far more important are the terms and conditions of the transaction. 

 Lease Vs. Bank Loan

A typical lease contract finances as much as 110% of the equipment cost because it usually picks up delivery, installation and training costs.  It only requires one month’s rent in advance; there is a UCC filing only against the specific equipment leased; and the leasing company won’t bother you for the next five years as long as you make your payments.  At the end of that time, they will sell you the equipment for its then current fair market value (which is probably minimal); and you will have expensed the payments for tax purposes. 

 On the other hand a bank loan at a “lower” rate usually requires that you keep 30% of the loan amount in compensating balances in a non-interest bearing account at that bank (so the bank is really lending you 70% of their money and 30% of your own money).  When you compute the real yield on that, you find that an 8.5% loan is really a 25% loan (because you’re paying interest on 100%, but only getting 70%).  Using the same formula, a 20% compensating balance yields almost 19% and a 10% compensating balance about 14%.

 So you have this “low” bank rate, but you have to leave part of the money in the bank.  You also have covenants that require you to maintain certain financial ratios, the bank has filed a blanket lien against your assets and you are cross-collateralized with your kids’ trust accounts, your personal accounts, and everything else. There is probably a clause in the loan agreement that says that if at any time the bank feels uncomfortable with the industry that you are in, they can call the loan even if you have made every single payment on time.  There is probably a clause that says if their cost of money goes up they can change the rate to compensate.  In short, you have more restrictions and less protection than you thought you were going to have.

 Thus “rate” is not the only factor in making a decision of how to finance a particular piece of equipment.  You have to look a lot deeper. 

 Flexibility Through Leasing

Your Leasing company may vary lease payments to match your cash flow curves.  If you are in a seasonal business, that can be a lifesaver.  We will also match the payments to the logical period of time that you will be using that equipment before it is necessary to upgrade; and will usually allow you to upgrade without penalty. 

There are a number of these “custom” features available in a lease contract that usually isn’t in a bank lending agreement and they affect your net cost.  So, when considering any type of financing, look beyond rate alone to the underlying considerations.  You may find that, in some cases, “it costs less to pay more.”

Article contributed by PreferredLease