Equipment Financing and Leasing: What You Need to Know Spreading out the cost of your business's equipment is one way to make it more affordable.

Some of the equipment vital to business operations is painfully expensive. For a startup business in particular, the idea of affording necessary equipment can feel like mission impossible. At the same time, the business needs the equipment to make the money…to afford the equipment.

How does a business get past such a frustrating catch-22? Equipment financing and leasing is the answer.

What is equipment financing?

Equipment financing is the act of using a loan or lease to purchase or borrow hard assets for your business. It serves as a business financing option. You can use it to buy or lease any kind of physical asset. Physical assets can include anything from a restaurant oven to a company car.

Recently, an Equipment Leasing and Finance Association (ELFA) survey found that 80 percent of American businesses lease at least some equipment. Companies using leasing range from the Fortune 500 to Mom and Pop stores.

Related: When and How to Lease Equipment

The advantages of equipment financing and leasing

One big advantage is you will pay predictable amounts every month, thereby making budgeting a lot easier. You can even build business credit on a program like this. The equipment is great collateral. As a result, the lender probably won't want any other collateral.

Often, you'll put down less money than if you were buying the equipment. You also might be able to negotiate flexible terms. Plus, it's easy to upgrade equipment once your lease ends. This is helpful if your equipment is something like a computer, which can quickly become obsolete.

The disadvantages of equipment financing and leasing

But there are disadvantages as well. Your down payment can be large. Good personal credit is often necessary to qualify. Another downside is if the financed equipment becomes outdated. At that point, your business ends up being stuck with it until the end of the lease or loan.

Often, leases can end up costing more than buying. When the lease ends, you'll need a new lease or will have to make some other arrangement. In contrast, buying equipment makes it yours to keep or to sell.

What you should be asking about equipment financing and leasing

What sort of equipment do you need? And how long do you need it for? Are you looking to bundle supplies, training, service and the equipment lease into a single contract? Have you thought about your company's future needs, so you get the right equipment? What will be the total cost of your payment?

Related: Leasing Equipment

Crucial need-to-know's about any lease

It is vital to know who you will be dealing with. There could be a separate company financing the lease. You'll need to know how long that company has been operating. You will need to make sure you understand the terms and conditions of the lease period, both during and at its end.

Find out if casualty insurance is necessary to cover damage to the equipment. Is it included in the cost? Learn who pays personal property tax. Find out options for trading in or upgrading the equipment before the lease period expires. Get clarity on who has responsibility for any repairs.

Fair market value leasing

It is also called an FMV lease. With an FMV lease, you make regular payments when you borrow equipment for a set term. When the term ends, you have the choice to return the equipment or buy it at fair market value.

$1 buyout leases

This is a type of capital lease. You pay for the cost of the equipment, plus interest. This is over the course of the lease. In the end, you owe exactly $1.

Once you pay the $1 residual, which is essentially a formality, you will fully own the equipment. This type of lease is a lot like a loan when it comes to structure and cost.

10 percent option leases

This lease is just about the same as a $1 lease. But at the end of the term, you can choose to buy the equipment for 10 percent of its costs. These arrangements tend to have lower monthly payments than a $1 buyout lease.

How much can a lease cost?

Here's an example. Let's say you are leasing a $25,000 piece of equipment. Call it a 15 percent option, with a 36-month term.

The value of the equipment is $25,000. The interest rate is 15 percent. The term length is 36 months. The monthly payment is $780. The total cost of leasing equals $28,079. And the cost to purchase is $2,500. Hence the total cost of equipment is $30,579.

With the above example, you would pay an additional $5,579 over the course of the lease. That is over one-fifth more added to your total cost for the equipment.

If you bought the equipment outright from the start, your cost would be $25,000. As a result, you would be $25,000 in the hole from the beginning. But with leasing, you haven't spent the total $25,000 until over two and a half years have elapsed.

Equipment financing and leasing: takeaways

Businesses often have fluctuating revenue, but they still need equipment. And for startups, they need equipment to get going, but they can't afford it. Equipment financing and leasing can be the ideal solution. There are advantages and disadvantages to leasing equipment. This is just like any other form of lease versus purchase.

Like with all financing, read the fine print and understand the terms before signing.

Related: A Small Business Owner's Guide to Funding Options Without a New ...