Getting the latest equipment and machinery to support a construction business can give contractors a huge competitive advantage. However, upgrading construction equipment is also a significant financial decision. Construction equipment is generally expensive. With payment issues plaguing the construction industry resulting in companies going great lengths to protect their lien rights, a huge cash outflow may throw a wrench on finances.
Contractors have two routes for construction equipment acquisition: equipment leasing and equipment financing. Both are valid choices, but they have different advantages and disadvantages depending on the business situation. Contractors will need to consider the type of equipment needed, the cost of its maintenance and repair, its resale value and the size of the business.
Should contractors lease equipment or get financing? To help with this decision, here is a comparison of the risks and benefits of equipment leasing versus equipment financing.
Benefits of Equipment Leasing
1. No down payment
One of the best reasons to consider leasing a piece of equipment is its relatively mild impact on cash flow. Unlike equipment financing, contractors do not need a down payment—in the rare times that they do, it’s in the form of a deposit and is significantly less than a down payment.
2. Stay up to date with current technology
Replacing equipment that becomes outdated rather easily takes a dent in a contractor’s cash. If a company finds itself needing to upgrade equipment often, leasing is a great option. With leasing, the company is not obligated to purchase the equipment at the end of the lease, giving it the flexibility to open a lease on a newer piece of equipment.
3. Easy asset management
Contractors are only responsible for a piece of leased equipment when it is in their possession. The lessor will be ultimately responsible for its maintenance and its disposal at the end of its useful life.
Drawbacks of Equipment Leasing
1. Higher total cost
When contractors lease a piece of equipment, they will end up paying higher costs over time compared to taking an equipment loan and buying it outright. This is because the lessor puts an effective interest rate on monthly payments to gain profit, which ends up getting higher than the loan’s interest rate.
2. Maintenance problems
Since the equipment owner is usually in charge of maintenance, the contractor will be dependent on the schedule of the owner in case the piece of equipment breaks down. Any delay in much-needed repairs will disrupt your operations.
Benefits of Equipment Financing
1. No collateral needed
Equipment loans are self-collateralized. Most lenders are satisfied with using the equipment to be purchased to secure the loan. There will be no need for contractors to put up real estate or vehicles as collateral. This significantly lowers their personal risk.
2. Easy to qualify
Because equipment loans are self-collateralized, most lenders are willing to consider businesses with low credit scores. Most equipment financing companies will be more concerned with the condition and resale value of the equipment they are financing than the company’s creditworthiness.
3. Tax incentives
The government provides tax benefits to businesses that choose equipment financing. Section 179 of the IRS tax code provides a maximum annual tax deduction to business owners up to $500,000.
Drawbacks of Equipment Financing
1. A down payment is required
Equipment financing usually requires an initial down payment. Lenders usually only give around 80% of the cost of the equipment. Contractors will be responsible to pay for the remainder upfront. The upside is that the bigger the down payment, the better the contractor will be at getting a lower interest rate.
2. Risk of owning outdated equipment
Unlike equipment lease, contractors have full ownership of the financed equipment. However, this comes with the risk of it being obsolete at the end of the loan term. So before contractors apply for an equipment loan, ensure that the equipment to be financed will not be outdated quickly. Or else, they will be stuck with a piece of equipment that they may need to replace—even while they are still paying for it.
Which one is right for you?
The right choice between an equipment lease or an equipment loan depends entirely on contractors’ business situations. The main things to consider are how much cash is available now, what the needs of the business are and how quickly the equipment being considered will be outdated. If a contractor has the money for a higher down payment, it should choose equipment financing. But if a contractor is going to update equipment often, it should consider equipment leasing. Ultimately, contractors need to weigh the risks and benefits of leasing versus financing in the context of their business to make a sound decision.
