6 days Ago
This early in the year, many manufacturers are figuring out what their equipment needs will be for the year, and machine tool sellers are strategizing on how to sell machines. When the machine seller is also its manufacturer, it likely has established banking relationships and access to what may appear to be very competitive financing rates. Sellers that are the exclusive distributor for a line of equipment also offer rates, which at first glance look very enticing.
Here’s how to make a good decision when deciding where to lease/finance your next machine. The Application Process First, start by looking at the application process. There is no difference between using machine vendor financing and your existing funding relationship if your credit profile supports the transaction size.
Regardless of the underwriter, the application submission process is identical when it comes to disclosing the required financial information. Every lender looks for the same material. Assuming the application is approved, the terms are normally the same as well—anywhere from two to five years.
However, this is where the similarities end. Low Rates If the machine seller is also its manufacturer, it may offer some sort of lease rate subsidization, which essentially means it discounts the machine internally to offer what looks to be an attractive rate. However, if this discount can be taken as cash off the machine’s price, and the financing is arranged at market rates, the borrower is normally better off in the long run.
This is because the discount reduces the transaction size and, in turn, the cost of borrowing. In cases where the machine seller is not its manufacturer but instead an exclusive distributor, it sends the financing application to a specific financial institution to handle the transaction. It does this because it has an arrangement in place where the equipment is discounted, referred to as a blind discount (blind to anyone but the vendor and funder), and the lease is then based on a smaller amount.
The overall effect is the perception of below-market rates but, in fact, the lease is based at market rates but on a smaller transaction size. By the Numbers At the moment, the Canadian prime rate is sitting at 5.45 per cent.
As an example, a $250,000 transaction with a special offer of 3.99 per cent financing makes the monthly payment for a five-year lease $4,603 per month, plus taxes. Now, if you can negotiate a 15 per cent discount from the list price of the machine purchase price, the total cost becomes $212,500.
Most banks will lend money at approximately 2 per cent above prime, or 7.45 per cent. Now the monthly payment becomes $4,227 per month, plus taxes.
Let me bring you behind the curtain: a bank always provides the cheapest cost when borrowing. There are several reasons for this, but in the simplest terms, banks are deposit-taking institutions, which enables them to have a low cost of lending. On top of that, a bank transaction is highly secured, so there is almost no risk of loss.
A property mortgage is a great example of this. A bank typically only lends 70 to 75 per cent of the value of the property, giving it an equity position from Day 1 because the lent amount is less than the asset’s value. It is very similar when it comes your business.
The bank finds security in your assets and guarantees of shareholders, which is larger than the amount it is lending to you. Continuing with the payment example, a shop uses a leasing company because it is either capped with its bank, it is a young business without a good credit profile, or it needs funds quickly and its bank is not responding in a timely manner. By using a leasing company and paying a premium of 1.
5 per cent, which makes the rate 8.95 per cent, the payment is $4,374 per month plus taxes, which is still far below the “special offer.” It also is important to review these proposals because in many cases when the attractive rate is offered, the deal is structured in a manner that requires a large deposit up front.
The machinery vendor may only offer to fund 80 per cent of the equipment to mitigate the risk in offering lower financing. If the underwriting is being done by an equipment manufacturer that does not have expertise in lending, it will require a deposit even when the borrower can get 100 per cent of the financing from its chosen institution. The deposit gives the seller a level of comfort in the event that the deal goes bad and the equipment has to be repossessed and resold.
This is another reason why it is best to negotiate a healthy discount and then fund the transaction elsewhere. With all that said, I do think taking advantage of vendor lending programs can assist manufacturers that require new equipment when the transaction size does not match their credit profile. The reality is, when it comes to finding the best financing for a particular purchase, many options exist in the marketplace.
It is, however, very important to ensure they are all evaluated in real terms before making a final decision..
