Leasing or financing? Comparing interest rates
When it comes to acquiring assets or property for your business, there are two common options: leasing or financing. Both have their advantages and disadvantages, but one factor that many business owners consider is the interest rate. In this article, we will compare the interest rates of leasing and financing, and explore which option might be best for your business.
Leasing
Leasing is a popular option for businesses that need equipment, vehicles, or other assets but don’t want to purchase them outright. With a lease, the business essentially rents the asset from the leasing company for a set period of time, usually a few years.
One of the advantages of leasing is that the interest rates can be lower than those for financing. This is because the leasing company retains ownership of the asset and is taking on the risk of depreciation and resale value. As a result, they may be able to offer lower interest rates than a financing company, which would require collateral as security for the loan.
Another advantage of leasing is that the payments are often tax-deductible. This can be a significant benefit for businesses that want to reduce their tax liability.
Financing
Financing, also known as a loan or a lease-purchase agreement, involves borrowing money to purchase an asset outright. The loan is secured by the asset itself, which means that if the borrower defaults on the loan, the lender can seize the asset to recoup their losses.
The interest rates for financing can be higher than those for leasing because the lender is taking on more risk. The borrower owns the asset and is responsible for its upkeep and resale value. If the borrower defaults, the lender may not be able to recoup the full amount of the loan by selling the asset.
However, financing also has advantages. One is that the borrower owns the asset outright, which means that they can sell it or trade it in at any time. With a lease, the business does not own the asset, and if they want to terminate the lease early, they may be subject to penalties.
Comparison
To compare the interest rates of leasing and financing, we need to look at the annual percentage rate (APR) for each option. The APR is the interest rate plus any fees or charges that are included in the lease or loan.
Lease APRs are typically lower than financing APRs because the leasing company is taking on less risk. However, the total cost of a lease can be higher than the total cost of financing because the business is paying for the use of the asset rather than ownership.
For example, let’s say that a business wants to acquire a new vehicle with a cost of $30,000. The leasing company offers a lease with a 2% APR for three years, with a residual value of $15,000. The financing company offers a loan with a 4% APR for three years, with a down payment of $5,000.
With the lease, the business would make monthly payments of $625 ($30,000 - $15,000 = $15,000 ÷ 36 months = $416.67 + 2% APR). The total cost of the lease over three years would be $22,500 ($625 x 36 months).
With the financing, the business would make monthly payments of $667 ($20,000 ÷ 36 months = $555.56 + 4% APR).The total cost of the financing over three years would be $24,012 ($667 x 36 months + $5,000 down payment).
In this scenario, the leasing option is cheaper than financing, despite the higher interest rate for financing.
Conclusion
Deciding whether to lease or finance depends on your business needs and financial situation. If your business requires assets that will rapidly depreciate in value or need to be upgraded regularly, leasing may be the best option. Leasing can also be more tax-effective as payments can often be deducted as an expense.
Financing, on the other hand, may be the better option if the asset has a long life span or if you need to own the asset outright. Financing can also build up equity over time and can be used as collateral for future loans.
Ultimately, it’s important to carefully consider both options and to weigh up the costs and benefits of each before making a decision.