The core difference
With an equipment loan, you are buying the equipment. The lender pays the vendor, you take ownership, and the lender typically holds a lien on the equipment until the loan is repaid. When you make the final payment, the equipment is yours free and clear.
With a lease, the leasing company owns the equipment and you pay to use it for a set term. What happens at the end depends on the type of lease. Some leases are effectively purchases with a nominal buyout, while others are true rentals where you return the equipment or pay its fair market value to keep it.
Neither option is automatically better. The right choice depends on how long you will use the equipment, how quickly it loses value or becomes obsolete, how much cash you want to keep on hand, and how you want it treated for tax and accounting purposes.
How equipment loans work
Equipment loans are typically structured with fixed monthly payments over a term tied to the useful life of the equipment. Because the equipment secures the loan, lenders may approve businesses that would not qualify for an unsecured loan of the same size.
Many lenders require a down payment, though some finance most or all of the purchase price for qualified borrowers. You may also be able to finance related costs such as delivery and installation, depending on the lender.
Ownership has advantages. You can modify the equipment, use it as much as you need without usage limits, and sell it later. Once paid off, the equipment continues producing value with no payment attached.
The trade-off is that you carry the risk of obsolescence and resale value. If the equipment becomes outdated before the loan is repaid, you may still owe on something you no longer want to use. You are also responsible for maintenance and repairs once any warranty expires.
How equipment leases work
A fair market value lease, sometimes called an operating or true lease, typically offers lower monthly payments because you are paying for the use of the equipment rather than its full cost. At the end of the term, you can usually return it, renew the lease, or buy it at its then-current fair market value.
A $1 buyout lease works more like a loan. Payments are higher because they cover essentially the full cost, and at the end you purchase the equipment for a nominal amount. Leasing companies offer other structures as well, such as a fixed purchase option set as a percentage of the original cost.
Leases often require little or no down payment, which helps preserve cash. Read the agreement carefully for maintenance responsibilities, insurance requirements, usage limits, return conditions and any automatic renewal provisions, which can extend the lease if you do not give notice in time.
Tax and accounting considerations
Tax treatment can differ between loans and leases. When you buy equipment, including with a loan, you may be able to depreciate it and, in many cases, use Section 179 expensing or bonus depreciation to deduct a large portion of the cost in the year it is placed in service. With a true lease, lease payments are generally deductible as a business expense instead.
Some leases, such as $1 buyout leases, are generally treated as purchases for tax purposes. The rules depend on the specific terms of the agreement, and annual limits for Section 179 and the bonus depreciation percentage can change, so speak with your tax professional before deciding based on taxes alone.
Accounting standards also require many leases to appear on the balance sheet. If your lenders monitor financial ratios through loan covenants, ask your accountant how a lease or loan would affect them.
When financing tends to make sense
Financing often makes sense when the equipment has a long useful life and holds its value, such as heavy machinery, trucks, trailers and many types of manufacturing equipment. Over the long run, owning is usually less expensive than leasing the same asset repeatedly.
It also suits businesses that want to customize equipment, use it heavily, or build assets on the balance sheet. If you have the cash for a down payment and expect to use the equipment well beyond the financing term, a loan is often the more economical route.
When leasing tends to make sense
Leasing often makes sense for equipment that becomes outdated quickly, such as computers, some medical and diagnostic technology, and specialized software-driven equipment. Returning it at the end of the term and upgrading can be simpler than reselling older equipment.
Leasing also helps when conserving cash is the priority, when you need equipment for a specific project or limited period, or when you want predictable costs that may include maintenance.
Whichever you choose, compare the total cost over the period you expect to use the equipment, including down payment, all payments, fees and any buyout. A WellRounded Capital advisor can help you compare a loan and a lease on the same piece of equipment side by side.