Should I Consider a Commercial Loan vs. Leasing Equipment?
There is a common perception—particularly for IT equipment—that leasing is an easier, more efficient, and more cost-effective way to procure equipment than using commercial business loans or other forms of debt to purchase the equipment. There are several reasons for this view:
- If risk is properly capped in lease agreements, leasing can generally allow an enterprise to pay only about 90% of the original equipment cost (OEC) and then return the equipment when it has relatively little, if any, useful life remaining. This is seen as a way to avoid the cost of technical obsolescence.
- Many CFOs prefer to preserve their enterprise’s commercial lines of credit for needs that they deem to be more business critical.
- Using commercial lines of credit may put your organization out of compliance with bank covenants.
Commercial Business Loans: No Strings Attached
Equipment leasing companies will generally offer lower lease rates than the interest rate received on commercial business loans. But a lease rate is not the same as the interest rate from a bank. To determine the actual financing cost of a lease, you must look at all costs associated with the lease—fees, penalties, interim rent, lease extensions, buyout cost, etc.
When evaluated in this manner—with full financial analysis as opposed to a simple comparison of lease rate vs. interest rate—commercial business loans may become much more appealing. Organizations are often enticed by the opportunity to lower equipment costs by entering into low-rate leases and successfully managing the high risk that lease agreements contain. However, if you fail to lower and manage equipment lease contract risk, the result could be disastrous—it’s not uncommon to pay as much as two times the OEC.
Commercial business loans, on the other hand, are generally “no surprises” transactions. Risk is virtually nonexistent—the interest rate is the cost, and that’s it. And commercial business loans provide a critically important additional benefit—you have control over the equipment refresh schedule, keeping you from losing leverage by being tied to a lessor’s lease schedule.
Making a Choice
The crux of the decision between commercial business loans and equipment leases is your organization’s capability to adequately identify and control risk in lease contracts and operations. You need to realistically assess your business’ aptitude at negotiating to reduce risk in lease agreements and seek expert assistance if needed. Assumptions about returning equipment and achieving other operational goals (e.g., meeting notices, paying on time) should be measured against the historical record to determine how realistic they are. Unless you are very well-prepared in terms of leasing agreement expertise and operational capabilities to actually achieve the cost savings promised by equipment leasing, commercial business loans could be the more cost-effective choice for your business.