How to Compare Lease Financing Options Accurately

You’re shopping around for the best lease financing deal, but the quotes you receive make it difficult to compare your options. There are too many variables in each quote. Calculating the cost of financing is the trick to accurately compare lease financing options. What will it cost you to borrow the money you need to make your equipment purchase?

How is an Equipment Lease Calculated?

Let’s look at the variables involved in  lease financing. Understanding this will help you calculate the cost of each financing option. 

An equipment lease has multiple components:

  • Total cost of the equipment, including any additional fees, such as shipping, installation or training
  • Initial payment structure
  • Lease term 
  • Buyout option
  • Interest rate

These factors determine your monthly lease payment. 

Equipment Cost

An advantage of equipment lease financing is that you may include related additional fees and costs into the amount of the financing. This spreads those costs out over the course of the lease term rather than paying them all in one lump sum upfront. 

Naturally, the higher the cost of your equipment, the higher your monthly lease payments will be. However, this amount can be adjusted by changing other elements of the lease. For example, you can lower your monthly payments by increasing the lease term or making a larger first payment.

Initial Payment Structure

Some people choose to make a down payment (usually structured as a larger first payment), but in most cases, it’s not required. Again, this is another advantage of equipment lease financing. You don’t have to pay a large lump sum upfront (OAC). However, for some businesses, making a larger first payment is a benefit because it lowers the monthly lease payments. 

More common is an initial payment structure of the first and last monthly payment (or security payment) in advance. 

Lease Term

Equipment lease terms typically range from 2 to 5 years. The longer your term length, the lower your monthly lease payments will be. However, a longer term also means the total cost of financing will be higher. So it’s a question of what matters most for your business:

  • If you want the lowest possible cost of financing, go with a shorter term. 
  • If you want the lowest possible monthly payment, go with a longer term.

A shorter term costs less in the long run, but a longer term is usually more manageable. You will need to consider your cash flow.

Buyout Option

What happens at the end of the lease? There are several options you’ll be able to choose from at the time of signing your lease agreement, so it won’t be a surprise at the end. These options may depend on credit approval. The option you choose will affect your monthly payments. 

The most common end-of-lease options include:

  • $10 buyout – You own the equipment after buying it out for a nominal amount, usually $10 at the end of the lease.
  • Residual buyout – You own the equipment after buying it out for a percentage of the total purchase price at the end of the lease. This residual is usually 10% but varies depending on the type of equipment and credit approval. This residual lowers your monthly payments but you do need to be prepared for the buyout amount at the end of the lease term. 
  • Fair Market Value buyout – You own the equipment after buying it out for the fair market value of the equipment at the end of the lease as determined by the lessor. This can lower your monthly payments, but again, you need to be ready for the buyout at the end of the lease term.
  • Stretch Lease with an early buyout option – An early purchase option that’s predetermined as part of the initial lease structure, allows you to buy out your equipment early. This saves you money by eliminating the last few monthly payments before the end of the full lease term. Taking advantage of the early purchase option lowers your cost of financing.

Interest Rate

Of course, any financing option includes a cost of financing. The lender or lessor pays for your equipment upfront, and you pay them back over time with interest on the amount you borrowed. Think of it like “renting “ money. However, “interest” can be calculated in many different ways and this makes it very difficult to compare competing lease offers.    

Quoted interest rates can often be misleading and don’t give you an accurate understanding of your real cost of financing. That’s why we suggest calculating the actual cost of financing in real dollars.

Calculate the Real Cost of Financing

The best way to get a truly accurate picture of your financing options is to calculate the actual cost of financing your equipment. The cost of financing is the amount of money you’ll pay beyond the cost of the equipment over the course of the lease term. 

This calculation takes into account: 

  • The initial payment structure of the lease,
  • The lease term,
  • The monthly payment amount, and
  • The end of term buy-out option.

To calculate the cost of financing, you don’t need to do a bunch of complicated mathematics. It’s actually really simple!

Here’s an example of a recent transaction with average credit.  

Total equipment cost: $71,000

Initial payment structure: First and last payment in advance

Lease term: 5 years (60 months)

Monthly payment: $1,404.90

Buy-out amount: $10.00

Start by calculating the initial payment:

$1,404.90 (first payment) + $1,404.90 (last payment) = $2,809.80

Next, calculate the total of the remaining monthly payments:

$1,404.90 x 58 = $81,484.20

Now add those amounts together with the buy-out amount:

$2,809.80 + 81,484.20 + $10.00 = $84,304.00

Finally, subtract the total equipment cost:

$84,304.00$71,000.00 = $13,304.00

This is your total cost of financing the equipment. It will cost $13,304.00 to finance this equipment based on these lease terms. Divided over the term of the lease – in this case, 5 years – is a cost of $2,660.80 per year to “rent “ your money. Remember that equipment lease payments are usually a tax write off. 

Initial Payment:

$1,404.90 + $1,404.90 = $2,809.80

Total Remaining Monthly Payments:

$1,404.90 x 58 = $81,484.20

Add the Buy-Out Amount:

$2,809.80 + 81,484.20 + $10.00 = $84,304.00

Subtract Equipment Cost:

$84,304.00 – $71,000.00 = $13,304.00

TOTAL COST OF FINANCING:

$13,304.00   (or $2,660.80 /year)

 

How to Compare Lease Financing Options

The cost of financing calculation is the best way to compare apples to apples. When you know the exact dollar amount your financing will cost, you can make the best decision for your business. 

You can apply this method to any form of financing, not just lease financing. For every financing quote you look at, you can calculate the total cost of financing to determine what it will cost you in actual dollars. 

It’s important to note that a lease quote and a lease approval are not the same thing. 

A lease quote is a dollar amount calculated based only on the cost of the equipment. It takes no other factors into consideration, so it’s an overly optimistic estimate. 

A lease approval gives you accurate information based on all factors, including the credit-worthiness of your company. You will want to clarify this before making a final decision.  

See also The Truth About Lease Quotes for more information about informed decision-making when it comes to equipment financing.

At Lease 1 Financial, we work hard to provide an exceptional level of service to our clients, and this includes giving you actual dollar amounts to ensure you’re getting the best value for your money. If you have any questions about calculating the cost of financing, we’d love to hear from you! Contact us today

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