You recently returned from your state chiropractic association convention. While there, you found an adjustment table that will help improve the care your patients receive. Best of all, it fits within your budget.
Trouble is, you are not sure how you should finance it. Should you take out an equipment loan? Or would it be more beneficial to lease the table? The table’s manufacturer works directly with a financing company that can complete either financing arrangement. In short, it’s your choice.
Sitting in your office, you ponder the decision. Loan or lease? Lease or loan? You learned how to perform adjustments on patients in chiropractic school, but you probably didn’t get an education on how to differentiate between equipment financing options. Confused about your financing options, you may even surrender to the pressures and put off making a decision regarding the table.
Sound familiar? Unfortunately, you are not alone. Many chiropractors have trouble selecting a financing option when they plan to acquire new equipment. However, with a little homework, you will be able to determine whether a loan or lease is more appropriate.
Begin With Research
One way to make a more informed decision is to do your research before entering into any type of loan or lease arrangement. Start by examining the tax benefits of a loan vs. lease, and the amount of money you will have to pay up front to acquire the equipment. In short, look at more than the monthly payment under either financing option.
Certain tax advantages may be available with both financing arrangements. How-ever, it’s important to look closely at your individual situation before deciding what tax benefits may be available. And it’s always a good idea to consult with your attorney or financial advisor for specific legal advice before entering into any type of financing arrangement.
With an equipment loan, you can deduct the interest paid on the equipment and the depreciation expense over a period of years. Or, you may be able to deduct the full amount of the equipment purchase expense (up to $19,000 for 1999) in the year the equipment is purchased, under IRS Tax Code Section 179.
Under a lease arrangement, you can deduct the full amount of the monthly lease payment each year until the lease expires, assuming the lease payments are written off as operating expenses.
With a loan, a typical up-front payment is the down payment. This is the amount paid to the lender in advance, to enter into the loan agreement. Most lenders ask for 10% of the purchase price as the down payment, although some lenders may require a larger down payment. For example, the down payment on a $10,000 equipment purchase typically would be $1,000.
Acquiring equipment under a lease arrangement also requires the payment of certain up-front costs. For example, the first and last lease payments may be required; or the first and last lease payments and a security deposit. In some cases, it may be possible to enter into a lease arrangement without an up-front payment required (this situation may be particularly beneficial to new practitioners). But generally, the down payment for a loan or the up-front payment for a lease will be comparable.
There are several additional factors to consider when making the decision between a loan and a lease arrangement, including prepayment costs, the interest rate and buy-out costs.
With a loan, you are borrowing money to purchase an asset, such as medical equipment. Most loans are simple interest loans requiring you to pay the principal amount owed plus interest on the loan.
For example, if you purchase $10,000 of equipment, you will pay the required 10% down payment, and repay the monthly balance over 60 months (five years) at a 10% interest rate. If you decide to pay off the loan early, you are responsible for the principal amount due, plus accrued interest, on the date that you make the payoff. No additional interest is incurred and there is no penalty for prepayment of the loan.
In some cases, if you want to pay off a lease early, you may be responsible for the finance charges due through the end of the lease period, regardless of when you pay off the lease. For example, if you enter into a 60-month lease, you are responsible for 60 monthly payments. Each payment includes the principal amount and an implicit finance charge. This amount is due regardless of when you pay off the lease – whether it is in a lump sum payment on the second payment, or the sixtieth lease payment. In other words, in some cases there is no significant benefit in paying off the lease early.
With a loan, the interest rate is the cost of borrowing money. It will be explicitly stated in the loan contract.
It may be difficult to determine the interest rate in the lease, because of the manner in which leases are structured. In some cases, a number of equal lease payments are due up front plus the monthly payment over the term, plus a lump sum payment at the end of the lease. Because the amounts of the lease payments are different, it is more difficult to determine the actual interest rate charged for a lease.
As noted, with a loan, you can generally pay off the balance due at anytime without penalty.
With a lease contract, you will be given the option to purchase the equipment at the end of the lease term. This “buy-out” option is the price at which the leased equipment can be purchased at the end of the lease term. Generally, there are three types of buy-out options you will encounter:
- Dollar buy-out: With a dollar buy-out option, the lease specifies the dollar amount (sometimes only $1) required to purchase the equipment at the end of the lease.
- 10% purchase option: The 10% purchase option requires that 10% of the original purchase price will be paid at the time the lease expires, if the equipment is to be purchased by the lessee.
- Fair market value: The fair market value option allows purchase of the equipment at the “fair market value” (i.e., the price that someone would expect to pay for the equipment without a trade-in) at the expiration of the lease.
Before entering into either financing arrangement, examine any “hidden fees.” These fees must be explicitly stated within the contract. However, if you are uncomfortable with the terms of the financing arrangement and believe your concerns have not been addressed, it’s always best to consult with your attorney or financial advisor before entering into any type of agreement.
Penalties for Early Payoff
Some leasing companies charge extra fees for early payoff of the lease. For example, to pay off the lease contract early, the leasing company may charge as little as an extra month’s payment or as much as the full remaining balance due on the lease.
For instance, assume 30 monthly payments remain on a lease with a $200 monthly payment. To pay off the lease early, the leasing company will charge you $6,000 (30 payments X $200) without any discounts. Therefore, considering the circumstances, it may not be in your best interest to pay off the lease early.
Most loan agreements do not impose pay-off penalties. To determine the pay-off amount, contact the lender and request the pay-off amount on that specific date. The quoted pay-off amount will include the principal remaining and interest owed on that date.
Most financing companies file a UCC (Uniform Commercial Code) document with the Secretary of State where the equipment will be kept. The UCC informs the public that the lender holds a lien against the equipment. Costs to file the UCC vary from state to state; therefore, additional charges will be paid to the lender for filing the documents.
With some loan or lease arrangements, you may be charged a documentation fee that usually includes filing fees, postage charges and an up-front fee to the lender or lessor. This fee may range from $25 to $250 or greater depending on the company.
The Final Decision
Making the decision regarding a loan or lease financing arrangement may not be as difficult as it appears. Deciding which option will work best in different situations requires education, patience and a keen eye for details.
If you read it thoroughly, the information contained in most financing agreements makes sense. If however, questions remain, it’s always best to consult with your attorney, accountant or other financial advisors before entering into any type of contractual agreement.
Mr. McNerney is the president and chief operating officer (COO) of NCMIC Finance Corporation (NFC), and he is a director on the NFC Board of Directors. He has more than 20 years of financial experience within the banking industry, and he holds a master’s degree in business administration from the University of South Dakota. He can be reached at NFC at 800-503-0954 or firstname.lastname@example.org.