Lease Vs. Loan: Financing Options for Capital Equipment
Reduce costs while improving patient outcomes. That’s the mandate most hospitals are living by these days. However, the healthcare environment is not making it easy. Experts estimate there will be between $48 and $66 billion added to current health care costs each year between now and 2030. Over the last four decades, healthcare spending has increased 29-fold. The good news is that much of that spending is due to advances in treatments and technology. Capital medical equipment purchases play a critical role in patient care. However, hospitals are constantly weighing the pros and cons of investing in new equipment. Cash flow issues and budget restrictions often make outright purchases impossible.
Hospitals are meeting this challenge with flexible equipment financing. Flexible financing options offer an organization immediate access to new equipment and technology, often with no or little up-front cash. This is an attractive option for hospitals that want to conserve cash, reduce the risk of owning obsolete assets, and efficiently manage long-term assets by spreading payments over several years. What options are available?
What Defines Capital Equipment?
Before exploring financing options, first, let’s define capital equipment. In short, capital equipment is equipment used by an organization to produce other commodities or services. Capital equipment has an acquisition cost of $5,000 or more and a lifespan of more than one year. Here’s a quick checklist for determining if an item qualifies as capital equipment.
- It has an acquisition cost of $5,000 or more (including tax, freight and installation fees).
- It is not disposable. It must have a usable lifespan of at least one year.
- It is a stand-alone item, not part of a larger equipment setup.
- It qualifies as tangible personal property, meaning it can be appraised for value.
Another factor to keep in mind is that if a piece of equipment is purchased that adds value or extends the life of an existing piece of capital equipment, the additional piece is considered a capital purchase, regardless of how much it costs. The amount of the additional piece is added to the value of the existing equipment.
What about software purchases? Software that is included with hardware or other capital equipment is considered a capital expense regardless of the cost. If the software is not part of another capital purchase, it is considered a capital expense only if it has a value of $5,000 or more.
Financing Options: Lease Vs. Loan
In the absence of outright gifts or grants to fund new equipment, hospitals in need of capital equipment must decide how to pay for these expenditures. Even if cash is available, many organizations opt to preserve shareholder capital by financing equipment via lease or loan. Let’s discuss the pros and cons of each.
Simply put, a healthcare equipment loan provides a hospital with enough cash to cover the costs of professional-use medical equipment. Whether your organization uses a local bank or one of the numerous online lenders, many loan options are available. They typically offer flexible terms and processing is quick and efficient. Most equipment loans require a relatively small down payment since the equipment itself serves as collateral. Hospitals can even finance soft costs, such as taxes, delivery, and installation, as long as those costs do not exceed 25 percent of the total loan value. Payments are affordable, often spreading over the life of the equipment. The biggest perk is that once the loan is paid off, the equipment belongs to the hospital, free and clear. Hospitals also get to take advantage of the depreciation tax benefit. In addition to interest on the loan, some lenders also charge an origination fee that is deducted from the initial loan before the hospital receives the funds. A typical origination fee amount is 0.5 percent.
Medical equipment leasing is much like renting equipment. Hospitals pay a monthly fee, which is typically lower than a loan payment, in order to use the equipment. At the end of the term, the organization can decide if it wants to purchase the equipment or simply return it. Leases often require little or no cash up front, further preserving the organization’s cash flow. Buyback options vary based on the agreement, but typically the hospital will have to pay some type of residual in order to keep the equipment. For example, hospitals might opt for a plan that offers lower monthly payments with the option to pay current fair market value for the equipment at the end of the lease. A hybrid lease-purchase agreement is another common option. These plans offer higher monthly payments, but the buyback amount is something very trivial, such as $1. Perks to lease agreements include lower monthly payments and less cash up front. Additionally, the IRS allows hospitals to deduct 100 percent of the amount spent on medical equipment leases, up to $500,000.
Still not sure? Consider these questions when debating between a lease or loan.
- How long will the equipment be used? Leases are typically the answer for equipment used only in the short-term, meaning 36 months or less. If the equipment is needed for a specific contract and will not be used for other projects, for example, it would make sense to just lease until it was no longer needed. Simply put, the expense stops when the equipment is no longer needed.
- How much is budgeted per month? Leases offer lower monthly payments. However, if a loan fits the budget, it might make sense in the long term.
- How likely is it that the equipment will become obsolete while it’s still in use? Leasing reduces the risk of getting left with outdated equipment. Many lease contracts even allow for upgrades and replacements.
- How much flexibility is needed? Loans are subject to the lender’s rules. If flexibility is needed, equipment leasing contracts are more flexible. Contracts can include customized buyback options, extended rentals and trade options.
- Is the organization planning for more growth? Master lease contracts are expandable, allowing for multiple pieces of equipment to be added to a customized schedule.
While there are scenarios where purchasing outright is the right choice, loans and leases are the preference for many hospitals. In fact, Healthcare Finance weighed in on the subject saying, “the often-upgrading world of hospital equipment makes leasing the better option.” What was their rationale? “Leasing makes it easier to navigate regular equipment upgrades.” Improving patient outcomes and maintaining a competitive edge is critical for healthcare systems. Maintaining up-to-date equipment is key to achieving those two objectives.