What is a finance lease?
A finance lease is a contract between a lessor and lessee where the lessee requires the use of business equipment, vehicles or machinery, and the lessor provides the use of such equipment in exchange for pre-agreed regular payments. A finance lease is an option a lot of businesses take when buying expensive equipment outright just isn’t an option.
How does a finance lease work?
With a finance lease agreement, the asset remains the property of the finance company (known as the lessor), while you, the customer or lessee, receives exclusive use of the asset, paying for its hire over the length of the lease term.
A finance lease transfers substantially all of the risks and rewards of ownership of the asset to the customer, so that the asset appears on the customer’s balance sheet, with all outstanding rentals represented as a liability.
Key features of a finance lease
A finance lease generally conforms to one of two standard formats – the residual value lease or the fully amortised lease.
In a residual value lease, the diminishing value of the asset is reflected in the monthly rental, with a final balloon payment covering the estimated residual value at the end of the contract.
If the price, when sold, is above the predetermined balloon payment, then the lessor will usually refund a percentage of the proceeds to the customer. If the price is below the balloon payment, then the customer will be liable to cover any shortfall.
The customer is also responsible for the maintenance of the asset and any servicing that may be required. However, a separate maintenance contract may be possible and we are always happy to discuss this.
With a finance lease, the customer is accountable for any damage caused to the asset, so it is important to take out an insurance policy covering all potential damages that could arise over the lease period.
What happens at the end of a finance lease?
At the end of the finance lease period, the customer is usually given the option to extend the lease beyond the primary period or to return the asset. If an extension on the finance lease is not required, the asset will normally be returned to be sold on.
Alternatively, the customer could sell the asset to a third party on behalf of the lessor and may be given a rebate of rentals equating to a part of the sales proceeds, depending on the terms outlined in the original finance lease agreement.
What are the advantages of a finance lease?
- Set regular payments
- Minimal cost upfront
- Rentals are usually Corporation Tax deductible
- 50% of VAT can be claimed on the finance element
- Potential to carry on using the asset at the end of the lease period
- Additional line of finance that may not affect core banking arrangements