Equipment Financing Terminology 101: A Glossary for Business Owners

Equipment financing involves a variety of business terms—from assets and depreciation to leases and collateral. A clear glossary helps owners of construction, healthcare, IT or any small business navigate these concepts. Understanding each term lets you compare financing options and make smart purchasing decisions.

What Is Equipment Financing?

Equipment financing means using a loan or a lease to acquire machinery, tools, vehicles or other business assets. These assets are tangible items (excluding real estate) that your business needs to operate. In practice, you either borrow money to buy equipment or rent it over time.

Equipment Loan: Your company borrows funds to buy the equipment. The equipment itself usually serves as collateral for the loan.

Lenders often finance up to 80–100% of the purchase price, though some loans require a down payment. Loan terms can span months to many years, and you make regular payments of principal plus interest.
Equipment Lease: Your company pays periodic rent to use the equipment. Leases typically have little or no down payment and fixed monthly payments.

At lease end you may return the equipment, extend the lease, or buy it (depending on the lease type). Leasing can be easier when assets become obsolete quickly or when cash flow is tight.

According to the U.S. Small Business Administration (SBA), leasing can conserve cash and reduce maintenance risks.

For example, the SBA notes lease payments are typically tax-deductible operating expenses. But leases often cost more over time and depreciation deductions belong to the lessor (the owner of the equipment).

Equipment Loans

An equipment loan works like any secured loan. Key points:

Collateral: The equipment itself secures the loan. If you default, the lender can repossess the asset. This collateral lowers lender risk.
Interest Rate / APR: You’ll pay interest on the borrowed amount. The Annual Percentage Rate (APR) combines interest and fees into one yearly rate. Always compare APRs: a lower APR means lower total cost over the loan’s life.
Down Payment: Many lenders require an upfront payment (often 10–30% of the equipment cost). Better credit or larger collateral can reduce or eliminate the down payment.
Amortization: Equipment loans are usually amortized. That means equal payments cover both interest and principal over the term. Early payments are mostly interest; later payments increasingly pay down the principal.
Balloon Payment: Some loans (especially shorter-term loans) use a balloon payment. This is a large lump sum due at the end of the term that lowers monthly payments. Be sure you have a plan to make any balloon payment or refinance it.
Loan Term: Terms vary widely – typically 12 months to 10 years or more. Longer terms mean lower monthly payments but more total interest. Many lenders offer flexible terms or even interest-only periods for initial months.
Personal or Cross-Corporate Guarantee: Especially for small or new businesses, lenders often require a personal guarantee.

This is a legal promise by the business owner(s) to repay if the business cannot. In some cases, one affiliated company might guarantee another’s loan, sharing the liability.

Equipment loans usually appear on your balance sheet as both an asset (the equipment) and a liability (the loan). You can claim depreciation deductions on the equipment and deduct interest expense on your taxes, which can significantly reduce your taxable income over the life of the equipment.

Equipment Leases

An equipment lease is like a rental contract. Key terms and concepts:

Operating Lease (True Lease): The lessor (owner) rents the equipment to you for a period. You do not record the asset or full liability on your balance sheet under older rules (under current accounting rules, most leases do show up as a right-of-use asset/liability).

Lease payments are treated as operating expenses, and at the end of the term you return the equipment or renew. Operating leases offer flexibility and no ownership risk. The SBA explains that operating leases “work like a traditional rental” and are not added to your balance sheet.
Finance Lease (Capital Lease): This is a lease treated more like a purchase. Common triggers (from accounting rules) include a lease term that covers most of the equipment’s life or an option to buy at the end for a bargain price.

In a finance lease, you essentially own the equipment for tax and accounting purposes. You record it as an asset and claim depreciation; you also record the lease obligation as a liability.

Maintenance and risk of obsolescence rest with you, but sometimes monthly payments can be lower than a loan (especially if the lessor finances the equipment in exchange for eventual ownership transfer).
Fair Market Value (FMV) Lease: A type of operating lease allowing you to return, renew, or buy the equipment at its fair market value at term-end. FMV leases often have lower payments because you are not paying off the full value of the equipment, only the depreciation and rent for your usage.
TRAC Lease: Common for vehicles, this lease sets a pre-determined “residual value” and includes a Terminal Rental Adjustment Clause (TRAC). If the equipment’s actual market value differs at lease end, you either pay the difference or are credited for it.
Lease Terms and Options: Leases may include buyout options (like a 10% purchase option or $1 buyout), maintenance clauses, or step payment schedules that change over time.

Always review whether lease payments are tax-deductible (they generally are as operating expenses) and whether you can terminate or extend the lease.
No Ownership Risk: As the lessee under an operating lease, you aren’t on the hook for depreciation beyond any penalties. The lessor assumes value risk. In a capital lease, however, you bear that risk but gain the advantages of ownership (deductions and eventual title transfer).

Below is a summary table comparing loans and lease types:

Feature	Equipment Loan	Finance (Capital) Lease	Operating Lease
Ownership After Term	You own outright after payoff	Typically the lessee ends up owning	No ownership – return or renew asset
Balance Sheet	Asset (equipment) and Liability recorded	Lessee records asset + lease liability	Under new rules, lessee records ROU asset & lease liability; under old, none on books
Tax Deductions	Depreciation + interest expense	Depreciation + (imputed) interest	Lease payments fully deductible as expense
Upfront Cost	Usually a down payment (10–30%)	Often little or no down payment	Often no down payment needed
Term Length	Varies (1–10+ years)	Usually significant part of useful life (e.g. 3–7 yrs)	Usually shorter, flexible (may be 1–5 yrs)
Risk/Maintenance	Borrower takes all risk/maintenance	Lessee handles maintenance and obsolescence risk	Lessor often handles major maintenance (unless specified)
End-of-Term Options	N/A – you own it	Could have bargain purchase, or own it automatically	Options to return, renew, or buy at FMV

Key Financing Terms

Business owners should know these common terms:

APR (Annual Percentage Rate): The true yearly cost of borrowing, including interest and fees. Use the APR to compare loan or lease offers; a loan with a low interest rate but high fees may have a higher APR than a competitor.
Amortization: A schedule of fixed payments covering both interest and principal. With an amortized loan, each payment reduces the balance. Early payments are mostly interest, later ones mostly principal.
Balloon Payment: A large lump-sum due at the end of a loan or lease, used to reduce monthly payments. Common in shorter leases or loans. Ensure you can make the balloon payment or refinance it at term-end.
Collateral: An asset pledged to secure a loan or lease. Lenders can repossess it if you default. In equipment financing, the equipment itself typically serves as collateral, but lenders may also place liens on other assets.
Credit Score: A numerical measure of creditworthiness. Lenders check business and owner credit. Higher scores mean better rates. For new businesses, lenders often consider the owner’s personal credit.
Lien: A legal claim on equipment (or other assets) granting the lender the right to take possession if you fail to pay. Liens “secure” the loan. A UCC-1 financing statement is often filed to perfect the lien.
Down Payment: An upfront portion of the purchase price you pay. Reduces the amount financed. Typical down payments range from 0–30% depending on credit, lender policy, and equipment type.
Depreciation: An accounting/tax method of expensing an asset’s cost over its useful life. For example, a piece of equipment may be depreciated over 5 or 7 years under MACRS (Modified Accelerated Cost Recovery). Depreciation lowers taxable income each year.
Bonus Depreciation: A tax provision allowing businesses to deduct a large percentage of equipment cost in the first year. In 2024, bonus depreciation is 60% (down from 100% in previous years). It phases down by 20% per year until 0% in 2027, unless extended by law.
Section 179 Deduction: A U.S. tax deduction that lets you expense the full cost of qualifying equipment in the year it’s placed in service. For 2024, you can deduct up to $1,220,000 of equipment purchases (phase-out begins at $3,050,000). Section 179 is subject to rules and varies by year.
Loan-to-Value (LTV) Ratio: The percentage of the equipment’s value financed by the lender. Many equipment loans cover 100% of the equipment cost (especially if secured by the equipment), resulting in an LTV of 100%. Lower LTV may secure better terms.
Debt Service Coverage Ratio (DSCR): A financial ratio lenders use. It compares your cash flow to your debt payments. A DSCR above 1.0 means you have more cash flow than debt obligations, which lenders view as safer. A typical requirement might be DSCR ≥ 1.25.
Personal Guarantee: A promise that the business owner(s) will repay the debt from personal assets if the business cannot. Lenders often require this for small or startup businesses. It means your personal finances (home, savings, etc.) are on the line.

Financing vs. Operating Expenses

Capital Expenditure (CapEx): Money used to buy assets. Equipment loans and capital leases fall under CapEx, and allow depreciation and interest deductions.
Operating Expense (OpEx): Ongoing costs of running the business. Operating leases typically count as OpEx (rent), making payments fully deductible without depreciating the asset. Treating lease payments as OpEx can improve cash flow and simplify taxes for some businesses.

For more details on lease vs purchase, the U.S. Small Business Administration offers guidance on when to lease or buy equipment. Likewise, Investopedia has helpful articles (e.g., on capital leases and operating leases) that explain the accounting and tax differences.

Frequently Asked Questions (FAQ)

Q: What is the difference between an equipment loan and an equipment lease?

A: A loan means you borrow money to purchase the asset and will own it when paid off. The equipment is recorded as your asset and you take depreciation and interest deductions.

A lease lets you rent the equipment; you make lease payments and generally return the asset unless you exercise a buyout option. Under an operating lease, you deduct the lease payments as expenses; under a finance (capital) lease you treat it like ownership for accounting (record the asset and liability).

Q: What is a capital (finance) lease vs an operating lease?

A: In a finance lease (capital lease), most ownership benefits and obligations transfer to the lessee. Typically the lease term is long or there is an option to buy cheaply. The lessee records the asset and depreciation on the balance sheet.

In an operating lease, ownership stays with the lessor, and the lessee simply pays to use the equipment for a shorter term. Operating leases are treated as rentals: payments are operating expenses, and the asset often stays off the balance sheet (under older rules).

Q: What is a balloon payment?

A: A balloon payment is a lump sum due at the end of a loan or lease. It’s used to reduce monthly payments. For example, a 3-year lease might have small monthly payments and a 4th-year balloon, or a loan might carry a large final payment.

You should prepare to pay or refinance this amount. Some lenders allow full amortization instead, so ask in advance.

Q: How do tax deductions work for equipment?

A: If you buy equipment with a loan, you deduct interest expense and depreciation. You can use Section 179 to expense much of the cost immediately (up to limits), plus bonus depreciation if available.

If you lease, lease payments are generally fully tax-deductible as business expenses for the duration of the lease. Operating leases give you no depreciation (the lessor claims it), but you avoid large upfront costs. Consult the IRS guidelines or your accountant for current limits and rules.

Q: Do lenders require collateral or a personal guarantee?

A: Yes. Lenders typically take a lien on the financed equipment (the equipment is collateral). If the equipment value alone isn’t sufficient, they may also require a blanket lien on other business assets.

For smaller or newer businesses, a personal guarantee by the owner is common. That means if the business can’t pay, the owner’s personal assets (home, personal savings) could be seized to cover the debt.

Q: How do I compare equipment financing offers?

A: Look at the APR (total cost of borrowing) and the lease rate factor or money factor for leases. Check any fees, down payment, and balloon payment requirements. Compare terms (length, flexibility, maintenance obligations).

Also consider non-financial factors: for example, leasing might allow easier upgrades. Use tables or loan calculators to compare actual cash flows.

Sources like Investopedia and the SBA offer comparison tips. Remember, shorter terms typically mean higher monthly payments but lower total interest, while longer terms lower monthly cost but increase total interest.

Conclusion

Understanding the terminology of equipment financing empowers business owners to make informed decisions. Whether you run a construction firm, a medical practice, an IT startup or any other business, grasping terms like APR, collateral, capital lease, or depreciation is key to getting the right deal.

Always compare loans versus leases using these definitions, and consult authoritative resources (like the SBA or IRS) or professional advisors for the latest guidelines. A solid grasp of this glossary will help you secure financing on the best possible terms for your business.