The Truth about Early Pay-offs from Equipment Leasing Companies and other most Equipment Financing Commercial Lenders.
First and foremost, most equipment leasing documentation and equipment financing agreements do not provide for a simple interest pay-off. In fact, many organizations will simply require that all payments be made and do not provide early termination (pay-off of the contract) language. Please note that this is not always the case.
Let’s get started by defining a few terms:
Simple Interest Pay-off.
This is the method with which we are usually most familiar. In short… you pay interest only on the outstanding principle. The pay-off assumes NO accrual (meaning no additional interest) of interest beyond this ‘simple’ calculation. Here is a definition from Investopedia (https://www.investopedia.com/terms/s/simple_interest.asp)
Simple interest is a quick method of calculating the interest charge on a loan. Simple interest is determined by multiplying the daily interest rate by the principal by the number of days that elapse between payments.
Summary of Simple Interest Prepayment:
You pay interest only for the actual time that the funds have been extended by a lender to a borrower. It seems that this is not often the case and so ~ here are some variations that we have seen used over the years.
Other Early Pay-off Calculations.
Sum of the Remaining Payments:
Under this method there will be no discount at all. The contract will be paid in full … and thus there would not really be a financial incentive to prepay.
Net Present Value Calculation:
This pay-off methodology employs a financial calculation to determine a discounted contract buy out. Some, but not all, interest will be saved in the event of an early contract termination. Here is a link that may help to explain this rather complex calculation: https://hbr.org/2014/11/a-refresher-on-net-present-value
Simple interest plus 1% of the then principle balance added for each year that the contract has remaining until maturity.
For example: a 5 year contract with 3 remaining years would receive a prepayment of the current principal, plus 3%.
½ of the unearned income:
This method discounts the pay-off by ½ of the remaining interest due under the contract.
While there are certainly other methods and manners for lessors and other commercial lenders to compute an early contractual buyout of a lease or a commercial equipment loan, nearly all are a variation or a derivative of a simple interest pay-off. And so we will end this writing with some helpful guidance. Here is the question to ask your lender:
“If I prepay my contract will the computation be a simple interest calculation?”
If the answer provided is yes… you will then have the ultimate necessary follow-up question.
“Will that be stated as such in the documentation?”
You can take it from here!
We hope that this is helpful, and would enjoy assisting you with straightforward and uncomplicated commercial equipment lending & leasing. Please contact ~