By: GreatAmerica on February 10th, 2019
What's the Difference Between a Lease and a Loan?
If you have ever bought a house or a car, or started a business, you likely have experience with loans. A question you or your customer may be wondering is when to lease and when to borrow using a loan? In this blog, we will compare the two, as well as provide resources to equip you to have this conversation with your customers.
A loan is ideal for collateral you want to own at the end of the term; something that holds its value past the life of the agreement. A lease is best for something that depreciates quickly - like technology - and will not hold its value past the term.
The most important distinction between a lease and a loan is how the finance charges are paid. In a loan, the interest is amortized throughout the term. In other words, your customer is paying more interest at the beginning and more principal at the end. Leasing isn't free, but the finance charges are fixed throughout the term and are not paid separately from the borrowed amount.
Why Opt for Financing Over a Cash Purchase?
Before we more deeply explore the lease VS. loan analysis, let's briefly address why one would use financing instead of cold, hard cash in the first place. If your customers need new hardware, software, upgrades, or add-ons, and they want to spend their available cash more effectively, financing is the answer. Plus, as the solution and/or service provider, you benefit by adding monthly recurring revenue (MRR). Financing also allows for a stickier customer.
What does “sticky” mean? Find out more here: The 4 S's of Financing for Managed Service Providers.
The Traits of a Lease
What makes a lease unique?
- One fixed monthly payment
- Good for equipment that loses value
- Inclusive of soft costs (installation, training, implementation)
- No advance payment or deposit required
- No impact on bank lines
- Easy to upgrade or add equipment throughout term
- Lease rates not tied to credit risks
What is a lease rate? A lease rate factor is represented as a fraction or multiplier, and is used to quickly calculate a monthly payment. Learn more about how leasing is priced here.
The Traits of a Bank Loan
Similar to a lease, loans have distinct characteristics that make them different. It’s important to understand these nuances in effort to make the best recommendation for your customers. Here are some qualities that make a bank loan unique:
- Interest amortizes with more due at the beginning, and less at the end
- Rates can fluctuate and are tied to prime and economic factors
- Customer owns the equipment when loan is paid off
- The bank can put liens on customer assets as collateral
- Ties up customer’s business credit line and limits
- Limits customer’s ability to borrow for other investments
- Requires a down payment or deposit
- Inconvenient to upgrade or add additional equipment as needed
- Can be a rigorous approval and underwriting process
- Customers with less established credit may face higher rates
What is the Difference Between a $1 Buyout Lease and Bank Loan?
Similar to a $1 buyout lease, a loan for the equipment places the emphasis on ownership. In both cases, when the customer makes the final payment at the end of term, they will own the equipment and likely continue to use it.
When Does a Bank Loan Make Sense for a Customer?
A loan makes sense for customers who lack the need to use their bank lines for revenue-appreciating activities like marketing, hiring or inventory. It also makes sense if they plan to own and use equipment for a very long time. When equipment or technologies don’t have frequent improvements and upgrades, ownership could be the answer.
The best way to determine the right option for your customers is to consider the drivers behind their need to acquire the equipment. Below are a few qualifying questions to ask to determine the importance of their cash flow for the purchase:
- How long will the equipment be required?
- Will the equipment become obsolete while it’s still needed?
- How much cash would be required upfront for a lease or loan?
- Are there any new initiatives they want to undertake that will require working capital such as expanding, hiring or R&D?
The Verdict: Equipment Leasing Usage vs Bank Loan Ownership
Both leasing and loaning are wallet-friendly options for acquiring equipment. Yet, there are more distinctions between the two than you’d expect! When your customers instinctively say they don’t need to lease because they can use a bank loan instead, or they don't need to finance because they have cash, you can highlight some of the differences and benefits to them.
Through a lease, your customer can invest cash and credit into other areas of their business. They can have a consistent interest rate with no down payment, and even better, avoid the act of investing into equipment that quickly becomes obsolete. Do you have questions around leasing? Check out the FAQ.
Ultimately, both an equipment lease and a bank loan help your customer obtain the equipment their business needs. The ability to pay over the course of a series of months is much more approachable than committing to a large, upfront cost. Maintaining working capital, hedging against inflation, and forecasting with ease are the cherries on top. For a quick comparison between a lease, loan and cash you can keep on hand and share with your customers, check out this PDF.
GreatAmerica is the largest independent, family-owned national commercial equipment finance company in the U.S. and is dedicated to helping manufacturers, vendors, and dealers be more successful and keep their customers for a lifetime. A $2.4 Billion company, GreatAmerica was established in Cedar Rapids, Iowa in 1992 and has a staff of over 600 employees with offices in Iowa, Georgia, Minnesota, and Illinois. In addition to financing, GreatAmerica offers innovative non-financial services to help our customers grow. www.greatamerica.com