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‘Won’t get fooled Again”... Wasn't that a great classic rock song by 'The Who'. It also might be a different sort of battle cry by Canadian business owners and financial managers who want to better understand equipment financing rates when financing assets in Canada. The ever-elusive 'what's my lease interest rate?' will now be examined!
The actual rate in an equipment lease in Canada is determined by several factors. Knowing how it’s presented into your deal structure is critical. The actual cash flows that you pay out in the lease, and their timing also plays a key factor in who wins and who loses when it comes to yourself and your equipment lender. Oh, and by the way, we're on your side if you're a Canadian borrower in lease financing - although we recognize the need of course to for the lessor to make a reasonable profit.
In some cases, it is of course important to assess the final rate impact of some miscellaneous charges that you might incur to get a transaction completed. Things such as miscellaneous admin fees, legal fees, and even an appraisal if that is required can of course add up and impact that all-important final lease rate.
In Canada, we tend to keep things simple. Unlike the U.S. our two basic lease offerings are the full payout lease to own capital lease, as well as the lease to use, or operating lease also called the Fair Market Value lease. Equipment financing rates differ significantly in those two transactions.
The easiest to understand transaction when it comes to equipment financing rates is the capital lease transaction. It has only 5 elements, the term of the lease, interest rate, dollar size of your deal, monthly payment, and end of lease obligation or payment. If you can determine the other 4 you can very quickly and properly assess what your lessors requested final interest rate is. That’s done most efficiently with a financial calculator of course.
The operating lease is a little bit of a different beast when it comes to rate. We can actually make a case that you might never be able to figure out the lease interest rate on a fair market value lease. Why is that? Didn’t we say the interest rate calculation was quite simple? Well, the reality is that in an operating lease transaction the lessor makes a decision to invest some of their own funds into your transaction. You won’t necessarily be told what that amount is, so it affects the amount being financing - in effect, they have made a down payment for you on the deal.
The good news is that the operating lease transaction will always be a lower payment, and if you run the numbers sometimes you might find that the interest rate might even be negative! Again, that’s simply because the down payment has been made for you.
But, as in all things in life, its pay me now or pay me later, because in FMV transaction your obligation is to return or purchase the asset at the end of the lease term.
Another nuance, often missed by Canadian borrowers, is to enquire if your payments are being calculated in arrears or in advance. You can understand that by using the analogy about how people pay their rents and mortgages - both are calculated differently.
The timing of cash flows is also critical in lease interest rate calculations. Adjusting payments to reflect perhaps quarterly or annual payments by your firm dramatically changes the lessor's yield or profit on the transaction.
Naturally, all lease interest rates are driven by your overall credit quality. The better shape your firm is in financially allows you to negotiate a much better rate. The lessor borrows funds and marks them up depending on your firm's credit quality and the size and nature of the asset.
So, our bottom line today? A lot of different factors go into equipment financing rates. They can dramatically affect the final outcome of your lease from a cost perspective. Consider talking to a trusted, credible and experienced Canadian business financing advisor on achieving the best equipment financing rates in Canada. Or as the song says... 'Won’t get fooled again'!
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