“Make Sure You Understand A Leases Prepayment Options Before Entering Into An Equipment Leasing Agreement”
If you enter into an equipment leasing agreement for your business, it would be wise to make sure your fully understand your prepayment options before signing off on your commitment.
Prepayment is the act of repaying some or all future payments in advance of when they are due.
Any type of financing facility that requires payments over time like a lease financing arrangement, will have some sort of prepayment policy or clause or conditions written into the leasing agreement.
In general terms, if a loan or lease is based on a variable rate, prepayment can occur without penalty, meaning you can pay out the remaining principal balance without incurring any further costs.
When a financing facility is underwritten with a fixed interest rate, there is likely going to be some sort of prepayment penalty for paying the loan or lease down or out early.
This is because the financing company will acquire the funds at a fixed rate price and provide it to you at a markup price or a price with a margin built in.
If you pay out the lease early, there is no guarantee that the leasing company will be able to place the money prepaid in the market for a similar margin, and in fact could result in a loss to the financing company.
When we think of loans and mortgages more specifically, there are defined prepayment penalties that include three months interest penalties or interest differential. These penalties are calculated and charged on amounts paid in advance.
In the leasing world, there tends to be more confusion around prepayment penalties as there is a less formalized approach among lease providers.
For instance, most small ticket leasing companies providing financing under $200,000 will say that they don’t have any prepayment penalty at all and that you are only required to make all the payments in full.
But after closer inspection to the above statement, we can find an indirect prepayment penalty that does exist.
Referring back to our mortgage example, if you incur a prepayment penalty on a mortgage, you pay the penalty plus the principal you want to pay in advance and that’s it.
Small ticket leasing companies will not charge a prepayment penalty so to speak, but they will require you to pay all the remaining principal an interest in most cases.
Because the remaining future interest is going to need to be paid as well as the principal, then this effectively becomes a prepayment penalty of sorts.
Once again, this is not going to be the case with all lease agreements, but it is with most, especially for smaller financing amounts.
This is why its important to understand this aspect of your financing agreement, especially you have an intention to repay all or a portion of the lease back early.