For most construction businesses, construction equipment is indispensable. Having the necessary and up-to-date equipment to run your day-to-day operations is very important, but it can also be expensive.
Construction machinery and other specialized tools are costly to purchase all at once, especially for smaller companies that may not have enough capital. There are many options for funding your equipment needs, but the most common are equipment leasing and equipment financing.
If you are in the middle of making a decision between equipment leasing and equipment financing to meet your equipment needs, read this guide to understand their differences and arrive at a decision that best suits your situation.
- Differences between equipment leasing and equipment financing
- Which equipment funding option is better for you?
Differences between equipment leasing and equipment financing
In basic terms, the difference between equipment leasing and equipment financing can be described as follows:
- Equipment financing allows you to buy a piece of equipment.
- Equipment financing allows you to rent a piece of equipment.
That is a simplified explanation on how these two options differ from each other. However, you don’t just “buy” or “rent” a piece of equipment when you go with either of these two equipment funding methods.
To have a deeper appreciation of what these two options are and decide which is better for your equipment needs, it is best to understand what they are and how they work.
How equipment leasing works
Equipment leasing, as mentioned earlier, is similar to leasing a piece of equipment in which you pay an equipment lessor a certain amount of money in exchange for the right to use their machinery.
Equipment leasing agreements may vary depending on the lessor. Typically you have to pay a scheduled monthly payment to use a piece of equipment. There are also additional payment options such as coverage for repairs so the lessor will be responsible if the equipment breaks down while you are using it.
In general, equipment leasing implies that you will not own the equipment even with the regular payments that you are shelling out. You are simply paying for the right to use it.
How equipment financing works
Equipment financing is also known as equipment loan. In equipment financing, you borrow money from a lender and you use that money to buy equipment. Depending on the terms, equipment financing will require you to pay regular payments until you fully settle the loan. Only when you have fully satisfied the loan will you officially own the equipment.
On the other hand, if you fail to settle the debt and you default on the loan, the equipment itself acts as collateral. This means that the lender takes full ownership of the equipment if you fail to pay off the loan in a given period of time.
Similar to equipment leasing, equipment financing also does not make you the automatic official owner of machinery. Unlike equipment leasing, however, equipment financing allows you to pay regular amounts with the eventual result of finally owning the equipment.
Which equipment funding option is better for you?
To know which option fits your situation better, you must understand the pros and cons of both equipment leasing and equipment financing.
Advantages of equipment leasing
1. Flexible lease terms
Equipment leasing offers you the flexibility to make the calls. You can go for newer equipment or stick with an old one, and you can even have the option to buy a piece of equipment at the end of your term. This buying option is typically offered for a piece of equipment that is about to reach its end of life.
Equipment leasing is a better choice if you are looking to use a piece of equipment for a relatively short period of time, or if the equipment that you need is about to reach its effective useful life.
2. No down payment requirement
You are not required to hand a down payment if you decide to go for equipment leasing. Releasing a down payment is typically necessary whenever you buy a piece of equipment on a loan — a higher down payment usually results in a lower interest rate for your loan payment terms.
Equipment leasing is, therefore, better suited for parties who do not have enough capital to shell out a lump sum for an equipment down payment.
3. Easier asset management
When you lease equipment, you are not responsible for its regular maintenance and other similar concerns. Such responsibility usually still falls on the equipment lessor, and your obligations only apply as long as you are in possession of the equipment.
Equipment leasing is a better choice for parties with a short-term need for a piece of equipment and do not want to deal with the costly maintenance of machinery that they may not always use.
Disadvantages of equipment leasing
1. More expensive
If you do the math, leasing a piece of equipment will definitely be more costly if you lease it for a long time. You still pay an effective interest included in your monthly leasing fee, so if you lease equipment long-term, you are likely to pay more than if you just had taken out a loan and bought it instead.
2. Restricted usage
Since repairs and maintenance costs are shouldered by the equipment lessor, the lessor has the right to apply certain restrictions on how you can use their equipment. They may require to only use the equipment under certain conditions, and you have no choice but to adhere to their requirements.
3. No guaranteed ownership
When you lease equipment, you shell out regular payments but you will not have eventual ownership of that equipment. This may be a huge disadvantage for certain parties, especially for those who are looking to use a piece of equipment for a long time.
Advantages of equipment financing
Compared to equipment leasing, equipment loans are relatively less expensive in the long run.
Equipment financing or equipment loans are definitely better for parties who are looking to use a piece of equipment for a long time. Not only is it relatively cheaper, but it also allows you to use and eventually own a piece of equipment without waiting for a long period of time until you have saved up enough money to do so.
2. Easy approval process
Equipment financing uses the equipment itself as collateral for the loan. It is, therefore, a self-secure loan, so the qualification process is not as strict. On top of that, you are also not required to use any of your existing assets as collateral in the event that you default on your loan.
Equipment financing is therefore ideal for parties who are looking to buy a piece of equipment but do not have enough amount to pay for it in full. If you have some money for a down payment, chances are you will get approved for an equipment loan.
3. Eventual ownership of equipment
Equipment financing leads to your eventual ownership of the equipment. This means that the monthly or quarterly payment that you are shelling out will eventually result in your full ownership of the equipment that you’re using.
If you need specific equipment to conduct your day-to-day operations for a long time, equipment financing is most probably the better option for you.
Disadvantages of equipment financing
1. Costly down payment
Most equipment financing agreements require that you pay a down payment. When you pay a higher down payment amount, your loan interest rate will likely be lower. If you do not have spare funds to shoulder an equipment down payment, equipment financing may not be the most ideal option for you.
2. Full asset responsibility
When you buy a piece of equipment via equipment financing, you will be responsible for its regular maintenance and repairs if something goes wrong. The lender’s responsibility ends once they have given you the money — you will buy the equipment and therefore you are expected to take care of it.
This is an important consideration if you are looking at investing in your own equipment. You should factor in the maintenance and repair costs to avoid unexpected expenses.
Equipment financing allows you to buy equipment using borrowed funds, but once you buy equipment, you will have to stick with it until you pay off your loans. You may not ask the financing company to replace it even if it gets outdated or if better technology is released on the market.
The risk of dealing with an outdated piece of equipment is something that you may want to keep in mind. If you go for equipment financing, make sure that you invest in a piece of equipment that you can see yourself using for a long time.