In today’s unpredictable economy, many organizations are leasing rather than purchasing equipment. However, not all leases are beneficial; some actually end up costing more than expected.
High interest rates, hidden penalties and other charges can gouge the bottom line. A comparison of total lease costs versus total purchase costs is necessary to determine the best option. Take the following steps before signing a lease agreement.
Prepare
Become familiar with leases that appear to be a good deal. For instance, a lease company often has less stringent lending criteria than a bank and requires little or no down payment. Many offer one-stop shopping, providing the leased item along with terms and financing. Interest rates can be high and the agreement might have loopholes that favor the leasing company.
Determine Equipment Life Cycle
Knowing the longevity of leased equipment can save thousands of dollars. Unscrupulous leasing companies try to sell extended lease periods. On the surface, this looks appealing because payments are spread out over a longer period. However, the equipment may not outlive the actual lease, leaving the lessee stuck making payments on non-functioning equipment. The average life cycle of a computer can be three to five years, so signing a seven-year lease doesn’t make sense.
Consider a Line of Credit
Though it requires more paperwork upfront, a line of credit can be a smart alternative to a lease. Funds can be used for various reasons. Additionally, most credit-worthy businesses can pay as little as 3 percent or 4 percent interest on such lines versus lease rates that can go as high as 18 percent.
Perform Due Diligence
Check leasing companies’ track records via the Better Business Bureau and a credit rating company such as Dun & Bradstreet. Get references from past lessees and ask about their experience with the leasing company.
Thoroughly Review the Lease Agreement
Refrain from hastily signing an agreement without fully reviewing it. Get a copy of the agreement prior to making the deal and be sure to read the fine print, where loopholes favor the lessor.
Ask for more details or further clarification when necessary, including: What type of lease is contained in the agreement? Is it an operating or capital lease? The former, also known as the fair market value lease, usually requires lower monthly payments and allows the lessee to renew the lease, purchase the equipment at fair market value or return the equipment. The latter enables the lessee to spread out payments along with an equipment purchasing option (often at a reduced price, such as $1) when the lease expires.
Some construction equipment manufacturers have their own leasing programs. For instance, Caterpillar has a Cat Value Option Tax Lease. The lessee can lease equipment for up to five years, either returning it or purchasing it (with the dealer and buyer agreeing on price) once the lease ends.
Other points to clarify include a security deposit and penalties for extra miles, damage, or wear and tear. Who covers insurance, taxes and maintenance on the equipment? If the lessor offers insurance coverage, find out the cost first. Premiums can be much higher than those secured independently, and it may already be covered under a current insurance policy.
Finally, diligently maintain leased equipment because lessor maintenance fees can be costly.
Know and Protect Lessee Rights
Make sure the lease addresses defective equipment that breaks down prior to the lease ends. Is there a specific lease lock-in period? Lease length can lead to burdensome financial obligations, particularly if there is no asset in the end. What happens if the lease is broken early? Heavy penalties might be incurred. Know the answer before consenting to the agreement. What if a lawsuit arises as a direct result of the equipment? Upon lease termination, who covers the cost to pack up and ship the equipment back to the leasing company?
Consider Tax Implications
Pay attention to the tax implications of purchasing versus leasing. In many cases, leases can be written off as business expenses (except in the case of an operating lease, in which case the property is subject to tax depreciation rules).
Enlist an Accountant to Review the Lease
Accountants frequently review lease agreements and can spot potentially costly provisions. For example, never sign a personal guarantee (which states the lease signer will take personal financial responsibility if an organization can’t pay the lease).
Avoid enticingly low introductory monthly payments; that’s how unethical leasing companies operate. Once entered into, payments can balloon to as high as 11 or 12 times the original rate. Heed this advice for interest rates as well. Adjustable rates (where it fluctuates according to the prime rate) also can be hazardous. Fixed rates are far more appealing because they do not fluctuate over time.
By weighing the pros and cons of leases before signing, an organization will be in a more advantageous position to strike a good deal. An accountant or lawyer with lease experience, particularly in the construction industry, can review the agreement and ensure no surprises arise down the road.