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Loan/Lease Comparison

Businesses commonly use leases and loans as financing options. However, the two products differ in several important respects.

The following discussion will provide a brief overview of some characteristics and benefits loans in comparison to leases.

A loan is a financing agreement that allows a business to acquire, use and eventually own equipment after investing in a down payment. A loan may require the borrower to pledge other assets for collateral. But loans also can provide tax and accounting advantages that may best serve a company's financial structure.

A lease allows a company to acquire and use equipment while conserving its cash flow and lines of credit. Leasing also provides a new source of credit with the added benefit of being able to expense your lease payments in most instances. Leasing also can protect against equipment obsolescence when upgrades are included in a lease contract or the equipment is returned to the lessor at the end of the lease term.

Consider the following comparisons:

Loan or Sale Characteristics	Lease Characteristics
A term loan involves the advance of funds and requirement where the advance be repaid with interest over a specific period. The borrower holds legal title to the equipment.	Leases involve the payment of rent. The Lessee may have a right to purchase the equipment at the end of the lease or during the lease term, but the lessor generally holds legal title to the equipment.
A conditional sale differs from a lease in that the lessor has no expectation of return of the equipment and has no residual value at risk at the end of the term of the conditional sale transaction.	In a true lease, the lessor retains significant residual value, and tax advantages, and the lessee may return the equipment at the end of the lease term. This reduces the rent payment considerably below the cash requirement of a conditional sales contract.
An equipment loan usually requires a down-payment and finances the remaining cost of the equipment.	A true lease finances 100 percent of the value of the equipment expected to be used during the lease term.
Loan payments are made in arrears of each loan period.	Lease payments may be made in advance or in arrears of each leasing period.
Depending on the credit worthiness of the customer, a business loan may require the customer to pledge current or fixed assets for collateral. A non-recourse loan, however, limits the customer's liability to the equipment and related cash flows, insurance and certain indemnity payments. Equipment can be seized in event of default.	Leased equipment usually serves as the collateral needed to secure the transaction.
Loan or Sale Characteristics	Lease Characteristics
Interest only (but not principal) is deductible from state and federal taxable income. However, Section 179 of Internal Revenue Code (IRC) allows a deduction for qualified Section 179 property placed in service in 2007 of $125,000 ($160,000 for qualified enterprise zone and qualified renewal community property). This limit is reduced by the amount by which the cost of qualified property placed in service during the tax year exceeds $500,000. The property must meet rules for Section 179 of the IRC that qualify for depreciation, which includes off-the-shelf software. For qualified Section 179 Gulf Opportunity (GO) Zone property, the maximum section 179 deduction is higher than the deduction for most other section 179 property. Section 179 of the allows business owners to fully deduct in the first year the cost of many newly purchased assets, up to $125,000 in 2007 and $128,000 in 2008. The benefit covers most movable assets qualify such as moveable equipment. Permanent structures do not qualify.	Lessees may generally deduct rent in a true lease. In a non-qualified tax lease, the lessee and not the lessor may depreciate equipment and other tangible personal property (not buildings and improvements) used in their trade or business.
A loan does not alter borrower's full ownership of the equipment at the end of the loan term in the absence of any default.	A lease with a Fair Market Value purchase option allows the lessee to return the equipment without further obligation when the lease ends or purchase the equipment at its fair market value or other agreed price.
The user, as owner, bears the risk of equipment obsolescence and devaluation, due to development of new technology.	The end user transfers risk of equipment obsolescence to the leasing company, since no obligation exists to own the equipment at lease end. Some leases contain provisions for upgrading equipment during the lease term for additional rent.
Loans can be used to pay for a broad array of capital needs, including sales finance, inventory finance and business expansion.	Leases tend to finance items of equipment, software and services. A "Master Lease" acts as an umbrella for the financing of multiple deliveries of equipment represented and documented by schedules to the Master Lease.
The FASB requires owned equipment to appear as an asset with a corresponding liability on the lessee's balance sheet.	Leased rentals are expensed when the lease is an operating lease. These assets do not appear on the customer's balance sheet if the do not meet the criteria of a capital lease under FAS 13. This rule is subject to change in the next few years.