Sales Make it Happen
What is the correct answer to “What is my rate”
By Terry Winders
Many customers press the lease salesperson for the effective rate on the lease proposal. The answer, usually given, is the stream rate because that is all the customer legally has to pay. But because they are use to interest rates the customer wants to figure the rate including the purchase option to compare Lessor’s proposals.
With Purchase options at fair market value, or a fixed price, they usually are 20% higher than the residual to maintain the economic difference between a loan, and a lease, for tax and legal purposes.
So how to you avoid giving the customer the correct rate equivalent with out being in danger of losing the deal?
We usually answer that there is no rate, because this is a lease transaction. So most lessees do their own calculations, to arrive at a number, so that they can compare the offers received from competing Lessor’s.
Some talk about “yield,” while others in the past were to express the interest as “add on, “ not “annual percent rate.” And “in arrears” or “advance?” What the advance and/or security payment included or the residual, too, at present value?
Most will treat the lease as a “loan,” meaning use a “loan” program or chart, pressing a few buttons and arriving at a percentage. But before the customer gets out his HP Calculator or calls his Certified Public Accountant, let me advise the better answer gets to the question; is the rate question, an accounting issue, or a tax issue?
With recent tax laws regarding “depreciation,” many customers are very interested in not taking the lease payments as a “deduction,” but the depreciation and interest for the year declared. This may be to your advantage.
A tax true lease with a fair market purchase option has no rate because the rents are fully deductible for income tax considerations. However a true lease may still fail the 90% test for accounting and be classified as a Capital Lease. A Capital lease will brake down the payment into equipment cost to be amortized and interest. This is done by the lessee’s accountant by discounting the rental stream at their incremental borrowing rate IRB ( average cost of money under like circumstances). This means that regardless of the Lessor’s rate the discount factor will be the lessee’s actual borrowing rate.
Example: Non-tax lease for $100,000 over 36 months (in advance) with a FMV P.O. and a “0%” residual with a 12% rate equals payments of $3,288.55. The stream rate is 12% because of no residual but the FMV P.O. makes it a true lease for tax purposes. The lessee to book the deal, under GAAP standards, must discount the payment at their IRB and if the IRB is 10% the present value is $102.765.39 which must be amortized (depreciated) over the term of the lease.
The interest is calculated by subtracting the discounted amount from the total rents to be paid. The total rents, from the example, are $118,387.80 then minus the discounted value $102,765.39 will give you $15,622.41 (the interest to be deducted as interest expense over he term of the lease.) The interest is taken over the lease term under the interest method. Therefore, the rate for accounting will always be the lessee’s IRB which in this case is 10%. The true cash flow to obtain ownership at lease termination can never be computed until lease termination so using the IBR is usually the best alternative.
Remember, if they wanted to use their own cash or bank lines, they most likely wouldn’t even be talking to you at this stage. The main reasons most in small tickets lease is the convenience, and may also for the main reason in the mid-size: for better use of working capital and to save their existing line of credit. If the rate is competitive, you have won the deal.
The point is to sell the “lease” with all its advantages, including the “fixed” rate, focusing on the monthly payment.
Terry Winders, CLP
Lease training and Consulting