Every businesses situation is different; therefore, there is no single correct answer to this question. However, there are some basic principles that customers need to understand when deciding whether to pay out the contracts early or faster:
- Equity in equipment ties up cash – There are many other options for using capital for a business that provides a positive “return on investment”. If you choose to pay off your loan quickly and decide you need that capital in the future, it is very difficult (or expensive) to release that capital for other purposes.
- Most fixed-term Equipment finance contracts charge penalties for early termination. Suppose you pay off an equipment finance contract early. In that case, most financiers will retain a proportion of the future interest as a penalty for paying out early, therefore significantly negating the advantage of paying out early.
- Interest expense is tax-deductible – In most circumstances, the interest (or a proportion of it) is tax-deductible. By paying out your contract early, you will reduce your tax-deductible expenses.
One of the biggest mistakes is that the business goes through a good financial period and feel the need to “clear out” some debt. Then, there is a downturn in the market, or there is some negative impact on the business, and they don’t have the cash surplus to withstand the downturn.
Many businesses have the cash to pay for equipment. Still, they choose to finance the equipment as they understand the importance of conserving cash flow and “leverage” the business financially.