For equipment you will run for most of its useful life, a loan is usually cheaper; for equipment you will replace early, a true lease can cost about the same with none of the resale risk. A loan buys the machine: often some cash down, ownership from day one, depreciation, and years of use after the payments stop. A true lease rents it: little or nothing down, lower payments deducted as an expense, and a choice at the end to return, renew or buy at fair market value. Check how your senior lender's covenants count lease obligations before you sign either.
- Cash at signing
- Loan: often a down payment. Lease: often little or none
- Ownership
- Loan: yours from day one. True lease: the lessor's
- Tax
- Loan: depreciation, possibly Section 179. Lease: payments expensed
- Covenants
- Loan counts as debt; lease payments usually count as fixed charges
- Cheaper when
- Loan: kept long. Lease: replaced early or obsolete fast
Three products, not two
An equipment loan is a term loan to buy a specific asset. You hold title, and the lender takes a first lien on the equipment, usually as a purchase money security interest. The term is matched to the asset's useful life, and the lender underwrites both your cash flow and what the equipment would fetch if it had to be sold. See orderly liquidation value vs fair market value.
A dollar-buyout lease (also called a capital or finance lease) is a loan in lease form. You make fixed payments and buy the equipment for a nominal amount at the end. Tax and accounting treat it largely as a purchase. It belongs on the loan side of this comparison, and the differences are set out in FMV lease vs dollar buyout lease.
A fair-market-value lease (a true or operating lease) is a rental. The lessor owns the equipment, sets your payments on its cost less the value it expects to recover at the end, and gives you the choice at term of returning it, renewing, or buying it at its then fair market value. This is the real alternative to a loan, and the rest of this page compares the two.
Side by side
| Equipment loan | True (FMV) lease | |
|---|---|---|
| Cash at signing | Often a down payment | Often first payment or a deposit only |
| Soft costs (delivery, installation, software) | Sometimes financed, often paid in cash | Often built into the lease |
| Monthly payment | Higher: repays full cost | Lower: repays cost less expected residual value |
| Ownership | Yours from signing | The lessor's throughout |
| Tax deduction | Depreciation (possibly Section 179 or bonus) plus interest | Lease payments, as an operating expense |
| Balance sheet (GAAP) | Asset and loan | Right-of-use asset and lease liability |
| Effect on EBITDA | None: interest and depreciation sit below it | Lease cost reduces it |
| Usually counted as debt in covenants | Yes | Often not, but payments count as fixed charges |
| End of term | You own it outright; lien released | Return, renew or buy at fair market value |
| Ending early | Prepay the loan, sell the machine | Usually owe the remaining payments |
How long you keep it decides which costs less
A lease payment is lower because the lessor expects to sell or re-lease the machine at the end. You are paying for the part of its value you use up, plus the lessor's financing charge and margin. A loan payment repays all of the cost, but when it stops you still have the machine. So the question is simple: will you use enough of the asset's life for owning it to pay off?
Take a machine costing 1,000 with a long working life. The loan route is 100 down and 1,080 of payments over five years. The lease route is 850 of payments over the same five years. A used machine sold on the open market fetches less than the fair market value a lessor charges to leave it in place, so the table uses about 330 for a sale and about 400 for a lease buyout. The figures leave out tax, which the next section covers.
| You keep the machine | Loan route, total cash | Lease route, total cash | Which costs less |
|---|---|---|---|
| Five years, then replace | 1,180, less about 330 from selling it: net 850 | 850, and you hand it back | About equal, but the lease carried the resale risk |
| Ten years | 1,180, then five years with no payments | 850, plus a buyout at fair market value of about 400: 1,250 | The loan |
| Three years, then it is obsolete | Prepay the balance and sell a machine nobody wants | Remaining payments are still owed unless the lease allowed an upgrade | Whichever contract gives the cheaper exit |
The pattern holds across most equipment. Assets that hold their value and run for a decade, such as heavy machinery, trailers and production lines, favor the loan. Assets that are obsolete before they wear out, such as some technology and diagnostic equipment, favor a lease, ideally one that lets you upgrade midstream.
Tax: Section 179 against lease expense
When you own equipment, whether bought with a loan or under a lease that tax law treats as a purchase, the business depreciates it. Section 179 and bonus depreciation may let you deduct much or all of the cost in the year the equipment is placed in service, within annual limits that change; interest on the loan is deductible as well. A large first-year deduction can matter a great deal to a profitable business.
Under a true lease, you do not own the equipment and do not depreciate it. You deduct the lease payments as an operating expense. The lessor takes the depreciation, and in a competitive market some of that benefit comes back to you in the lease rate.
Which is worth more depends on your tax position, not the equipment. A business with taxable income it wants to shelter this year usually prefers ownership and the up-front deduction. A business with losses, or one that cannot use the deduction, may prefer a lease, because a deduction it cannot use is worth nothing to it and the lessor can use it. This is a question for your tax adviser, asked before the contract is signed, not after.
What your senior lender's covenants do with each
The idea that a lease keeps debt off the balance sheet is mostly out of date. Under current US accounting (ASC 842), a business reporting on GAAP records nearly every lease longer than twelve months as a right-of-use asset and a lease liability. What still differs is how your credit agreement defines its terms, and that can make the same machine look very different to your bank.
- Leverage. Funded debt usually includes equipment loans and finance leases, and often excludes operating lease liabilities. A true lease may not add to the debt side of a leverage covenant at all, where a loan adds its full balance.
- EBITDA. A loan-financed machine does not reduce EBITDA; its interest and depreciation sit below that line. An operating lease's cost usually runs through operating expenses and does reduce EBITDA. So the loan raises debt and leaves EBITDA whole, while the lease leaves debt alone and trims EBITDA. Which helps your ratio depends on the numbers.
- Fixed charges. A fixed charge coverage covenant commonly counts lease payments alongside principal and interest, so a lease is not free space under an FCCR test. See DSCR vs FCCR.
- Capital expenditure limits. Some credit agreements cap annual capex. A loan-funded purchase counts against the cap; an operating lease often does not, though some definitions capture it. See maintenance vs growth capex.
- Liens and baskets. If your bank holds a blanket lien, a new equipment lender needs a carve-out for its purchase-money lien, and the credit agreement will limit how much equipment debt and finance-lease debt you may add. Operating leases sometimes fall outside those limits. See equipment financing alongside a senior facility.
Before signing an equipment contract, read your credit agreement's definitions of indebtedness, capital expenditures and fixed charges. The cheaper deal can be the one that trips a covenant.
The end of the term is where leases cost money
A loan ends cleanly: the last payment is made, the lender files a release of its lien, and the machine is yours. A true lease ends with a decision, and the lease already sets its terms.
- Notice windows. Many leases require written notice of your choice within a set window before expiry. Miss it and the lease may renew automatically, often month to month at the full payment.
- Return conditions. The equipment must usually come back in a stated condition, with the cost of shipping, de-installation and repair on you.
- Fair market value. If you want to keep the machine, the price is its fair market value as the lease defines it. Negotiate how that value is set, or a cap on it, at signing, when you have leverage.
- No early exit. True leases are generally non-cancellable. Returning equipment early usually means paying the remaining payments anyway.
Getting either one done
Equipment lenders and lessors underwrite much as a conventional term lender does: a P&L, a year-to-date P&L through last month-end, a balance sheet and a debt schedule, plus the vendor's quote for the equipment. The equipment's resale value carries real weight, so a machine with a broad secondary market is easier to finance than a custom one. Transparent's book holds 244 lenders that write equipment, which lets a business compare loans and leases side by side rather than taking the financing offered at the vendor's counter.
For larger purchases, an SBA 7(a) loan is another option, with maturities up to 10 years for equipment (15 if its useful life supports it); see equipment financing vs an SBA 7(a) loan. If you already carry expensive equipment debt, refinancing equipment loans and leases covers when that pays off.
Common questions
- Is leasing equipment more expensive than buying it?
- Over the full life of a long-lived asset, usually yes, because lease payments cover the lessor's financing charge and margin and you have to buy the machine or return it at the end. Over a short holding period, a lease can cost about the same as buying and reselling, without the resale risk.
- Can I take Section 179 on leased equipment?
- Not on a true fair-market-value lease, because the lessor owns the equipment; you deduct the payments instead. A dollar-buyout lease is generally treated as a purchase for tax, so the business may be able to depreciate it. Confirm the treatment with your tax adviser before signing.
- Does an equipment lease count as debt for my bank's covenants?
- It depends on the credit agreement's definitions. Finance leases are usually counted as debt. Operating lease liabilities are often excluded from funded debt, but the payments are commonly included as fixed charges, and the lease cost can reduce the EBITDA the covenants are measured on.
- My bank has a blanket lien. Can I still finance equipment elsewhere?
- Often, yes. Credit agreements usually permit a limited amount of purchase-money debt and leases, and the equipment lender's lien on the specific machine is carved out of the bank's. Check the permitted amount first, and expect the new lender to ask for proof that the bank's lien does not reach the equipment.
- Can I get out of an equipment lease early?
- Rarely without paying for it. Most true leases are non-cancellable, so returning the equipment early usually means paying the remaining payments. Some leases allow an upgrade or trade-in partway through the term, which is worth negotiating for equipment that ages quickly.