As an experienced leasing representative, I have the daily privilege of answering questions about equipment financing for enquiring customers and vendors. A few questions arise on a regular basis that are valid and important but, are not so easy to answer. For those who are not interested in the technicalities of finance, the response can be winded and difficult to understand. When evaluating leasing as a financing option for your next equipment purchase, consider these thoughts and ask your leasing representative some of the following, important questions:
What’s my interest rate?
I was once told that the definition of the word interest is quite simply “what you owe someone because you had to borrow something.” While this is pretty elementary, it’s also a pretty accurate explanation. I’ve heard the question asked many times and, because there are so many different ways to classify and calculate interest, there are quite a few different answers. The effective rate on a lease is not necessarily the nominal rate and simple interest is calculated differently than an “add-on” interest rate. Which approach is used to calculate interest is indicated for the accountants processing the transaction. Of all the different ways to arrive at an interest rate on a lease, it all boils down to the same thing: How much is it going to cost you to borrow the money you need to purchase the equipment you need? Leasing companies can provide different rates based on different compounding methods and accounting methods, but the amount you are paying for financing won’t change if the payments and the equipment cost stay the same.
Why is my rate so high?
There are a few things that influence the interest rate you pay. One of the biggest of these is the Federal Reserve Bank. The Fed sets rates that they charge when lending money to banks and for money lent between banks. When the Fed raises rates, banks pass the rate increases on to the customers to whom they lend. The Prime Rate is the minimum rate banks tend to charge their best customers. These are the customers with exceptional credit who often utilize other services of their lender.
Credit scores also determine the amount of interest you will pay on a lease or loan. The main reason for this is lenders will incur less costs by servicing dependable, paying customers. Costs of servicing a lease or a loan go up drastically once a customer fails to make payments. The better your credit is, the more banks are willing to compete for your business by offering you attractive, low financing rates. New businesses will pay a higher rate because they have no credit and failure rates of start-up companies are high.
Shorter, useful asset life or lower resale value also affect interest rates available to you, because collateral provides security for lenders. This is also why signature loans and credit cards charge much higher rates than a secured loan/lease for equipment.
Individuals typically borrow money at a lower rate than companies, because companies borrow to generate income whereas individuals borrow to pay for good or services. Lenders will charge higher rates knowing this.
Why doesn’t my interest rate or equipment cost appear on my contract?
Laws protect consumers who secure a bank loan by requiring the interest rate to be listed on the contract. Most loan contracts require the principle amount borrowed and the interest rate to appear on the agreement. Since laws differ by state and may vary throughout the country, sometimes interest rates are listed in terms of dollars to be paid rather than a factor or percentage. Leases are different. Leasing companies typically retain the title to equipment and because it is sold to them, they are not required to disclose the price they paid for the equipment. Interest rates do not appear on leases because they are not formal rates until any purchase options you have, are exercised.
If you have a Fair Market Buyout at the end of your lease, for example, an accurate interest rate cannot be calculated. To project their profitability or losses, leasing companies make assumptions about whether you will keep or return your equipment at the end of the term, to estimate an Internal Rate of Return (IRR). However, to provide such a rate to the lessee would be difficult. It may also have legal repercussions to do so, because until options are exercised, there is no determinable interest rate for the lease.
Bargain Purchase Options (or $1 buyout options) and leases with stated purchase options are a little different. These IRR estimates are easier for leasing companies to calculate, however, if these rates were provided to you in writing, the contract would be viewed as a loan, not a lease. There are different laws that apply and rules that must be followed for leases and loans. These laws often work to your advantage by extending attractive tax deductions and depreciation schedules for leased equipment that may not be available for equipment loans.
Rob Hardcastle is the Business Development Officer for Popular Leasing. He can be contacted at 800.829.9411, or by email at rhardcastle@popularleasingusa.com.
