An Overview of Leasing with the Top 5 asked Questions.
What are the different types of leases for equipment?
How does my credit score effect my ability to get a business equipment lease?
How do I get a copy of my credit report and FICO score?
Does my time in business effect my ability to borrow for equipment leasing?
What information and/or paperwork will I need to qualify for an equipment lease/loan?
- Should I use my business line of credit at my bank or secure a lease for the equipment?
- What collateral will the lease company require?
- What type of lender should I contact?
- What types of business equipment/products can I lease?
- What are my options if I can’t qualify for a equipment lease?
- What are the different types of leases for equipment?
- The standard equipment lease types:
- $1 out
- 10% Purchase Option
- 10% PUT
- Fair Market Value
$1 out lease:
- This lease allows you to own the equipment at the end of the lease for a $1 final payment. The payments on the lease are usually equal to a finance agreement loan, as both have a standard monthly payment with no real residual value at the end of the term. Also, you do not own the equipment until the end of term on a $1 buyout. The bank/lender maintains ownership. Leases are usually not designed for early pay off like a bank loan. The lending institution typically totals the monthly payments x months(Stream of Payments) left for a payoff. Some will allow a discount. Some companies will offer a discount on the stream of payments while others may actually charge a pre-payment penalty above the cost of the stream of payments for paying off early. Depending on the equipment/software or system you are purchasing you should be clear on the type of lease you have and ensure it is clear and in the contract. Never take a person’s word, legal documents are all that holds up in court . A finance consultant can help you with the fine print of these contracts.$1 Buyout Tax BenefitsThe fixed purchase price on a $1 out lease qualifies this lease as a capital sale (for accounting standards). It allows you to depreciate the lease/loan using Straight MACRS depreciation or Section 179 accelerated depreciation. The standard MACRS depreciation for most equipment is 5 years. However, equipment/buildings etc. can have much longer depreciation lives. Software/computer hardware are typically only 3 years. Your consultant can advise you on depreciation schedules or they are available at the IRS site. Section 179 depreciation is an accelerated depreciation which allows your business to accelerate the depreciation of the equipment in the first year up to a certain amount. Any amount of purchases over the annual allowed 179 will be carried over as standard depreciation for the remaining depreciation schedule of that equipment.Note: Section 179 has typically been $25,000. However there have been changes over the years. (In 1982 the IRS tax code initiated a provision for first year write-downs on the purchase of most personal property being used in a trade or business. This allowed operating companies to take advantage of an IRS Section 179 deduction on their business tax returns. In 1982 when Section 179 was implemented, the allowable tax deduction was $5,000, this amount was increased over the years, and in 2010 through 2013 the amount was $500,000. For 2014, that the maximum allowable Section 179 expense will drop to $25,000, reverting back to pre-economic incentive act limitations. This is a significant drop in the amount available and it should be factored into 2014 budget calculations.) There Is a proposal to permanently increase Section 179 to $500,000 per year but it has not been voted on in the budget. Currently, 179 stays at $25,000.(Note at the end of December the Congress and Senate voted to allow Section 179 to increase back to $500,000 for 2014. No vote has been made regarding the write off for 2015 at the time of this writing).
- The standard equipment lease types:
10% “PUT” or Payment upon Termination
- This lease is called a PUT in the finance industry. The advantage of a PUT is that your payments are lower during the term of the lease, but there is a final payment of 10% at the end of the lease. This balloon payment and the end allows for the lower payment during the term of the lease. A PUT usually qualifies as a capital sale and has the same tax benefits as paying cash or financing with an Equipment Finance Agreement, bank loan, or $1 out lease. This lease is different than an FMV or a 10% purchase option lease, in that the purchase at the end is fixed and not an option. The advantage of this program over an FMV lease is that the end payment is predetermined. MOST PUT leases do not have the ability to automatically renew like a FMV lease.
FMV – Fair Market Value Lease
A fair market value lease is a lease that has lower payments during the term and a balloon payment at the conclusion of the lease. The balloon payment is an estimated value of the equipment determined by the leasing company. In order to own the equipment at the end of the term you will have to remit that residual to the leasing entity at the conclusion of the lease. Most FMV leases have three options at the end of term: 1) Return the equipment, 2) Renew your lease payments for another year or pay month to month, or 3) Purchase the equipment for the FMV residual. If you choose option 2, please note: you will still have to pay the determined residual at end of term or return the equipment at the end of the term.
- A FMV lease may be cost advantageous if your company plans not to keep the equipment at the end of term. It is also a great program if your company needs to keep your payments low during the term for cash flow reasons. (Additional detailed information is available upon request).
- There are disadvantages to FMV leases and you should read the paperwork and end of term paperwork very carefully. Companies have ended up paying thousands more for equipment due to automatic renewals on FMV leases. Also, if you ship the equipment back you made be responsible for the shipping cost and any wear and tear the finance company deems to be outside of normal use. There are a lot of possible negative pitfalls to beware of with this lease, so please ensure that you read the fine print and are fully aware of all of the end term requirements. Also, ask if the finance company will give you a side letter with a cap of the end of term residual. A FMV lease is different than other leases in tax write offs. It is a true operating expense, so consult your CPA on the best option for your business.
How does my credit score affect my ability to qualify for a lease?
Your credit score is the most important aspect of financing. The standard credit scoring system in the US comes from the Fair Isaac Company. Fair Isaac condenses your credit information into one number based on formulas their analysts feel best gauge your credit worthiness. Scores usually average between 500-850. In some cases, such as securing a mortgage, the lender will combine the 3 scores and take the middle score average as their baseline score. Most finance companies use one standard company and it’s score when doing small business loans. There are 3 standard bureaus, Equifax, Experian, and Trans Union. All 3 companies may have different information and different scores for your credit, so you should review all 3 bureaus if you are considering any type of loan. When reviewing your credit if your credit score falls in a lower tier of the score system it will be much more difficult to secure financing and if you do your rate could be much higher than if you have a strong FICO score. A lender considers that if your personal credit is not good you will not pay your business loans on time either. So as an owner of a small business keeping your business score high and your bills paid on time is the most important thing you can do to ensure good credit worthiness for your business.
How do I get a copy of my credit reports and my FICO scores?
There is a lot of misinformation on credit scores, reports and how to really get a free credit report as mandated by the government. Below is information directly from the Government website. Please be aware: The free credit report companies with the funny songs are not the government approved sites. They require you to input a credit card and will start billing you for ongoing credit monitoring. Also, the scores on their reports do NOT and usually won’t match the scores that a bank or finance lender have on their reports. I had a client once who was very upset because he thought his scores was over 800 but when we pulled a business report it was in the 600’s. I contacted the credit bureaus who verified that the information DOES NOT usually ever match a score or report that a bank or business pulls. BUYER BEWARE. See below for information from the government on how to get your true free credit reports and how to contact the 3 major bureaus.
Get Free Copies of Your Credit Reports(Information from www.usa.gov)
‘Credit reporting is a system lenders use to decide whether or not to give you credit or a loan and how much interest they can charge you for it.
Your credit report is based on the bills payments you have missed or been late paying, loans that you have paid off, plus your current amount of debt.
A credit report contains information on where you work and live, how you pay your bills, and whether you’ve been sued, arrested, or filed for bankruptcy. Consumer Reporting Agencies (CRAs) gather this information and sell it to creditors, employers, insurers, and others. The most common type of CRA is the credit bureau.
The three major national credit bureaus are:
- Equifax, 1-800-685-11111-800-685-1111
Fraud Hotline: 1-888-766-00081-888-766-0008
- Experian, 1-888-397-37421-888-397-3742
Fraud Hotline: 1-888-397-37421-888-397-3742
- TransUnion, 1-800-916-88001-800-916-8800
Fraud Hotline: 1-800-680-72891-800-680-7289
Request your free credit report online or by calling 1-877-322-82281-877-322-8228. (Website for official free credit report sanctioned by the government is: https://www.annualcreditreport.com
Based on the information in your credit report, lenders calculate your credit score so they can assess the risk you pose to them before they decide whether they will give you credit. The higher your score, the less risk you pose to creditors.
The information in your credit report is used to calculate your FICO (the acronym stands for Fair, Isaac and Company) score. Your score can range anywhere from 300-850. Aiming for a score in the 700s will put you in good standing. A high score, for example, makes it easier for you to obtain a loan, rent an apartment, or lower your insurance rate.
Does my time in business affect my ability to borrow for equipment leasing?
Yes, your time in business can limit your ability to get approved for a equipment lease or other loan. If you are a new business you should contact a local organization that helps guide small business owners. SBA government programs might be a solution and most areas have SBA offices with volunteers that can help advise you in everything from writing your business plan to consulting on opportunities for funding. A new business may not have a lot of choices for loans but being creative and speaking to many bankers, finance associates and consultants can help you find more options. Be cautious of any company that request deposits and funds up front before offering you a valid approval or tangible proof that you have been approved for a loan or lease. Remember the saying “If it sounds too good to be true it probably is”.
Stay tuned for my next article with more information on securing equipment leasing or loans.