What is a Finance Lease? Asset Finance Explained
Updated 20 January 2022
A finance lease is one of the most common forms of asset finance. In this sense, a lease is a contract between a finance company (the lessor) and borrower (the lessee). The lessor purchases an asset from a supplier before hiring it out to the lessee in return for payment over a predetermined period.
During the lifetime of the finance lease, the asset remains on your business’s balance sheet and rental payments pass through profit & loss accounts.
There are a set of strict terms and conditions that will be set out at the start of the asset lease. These include things like the maintenance and insurance of the asset, which the lessee will be responsible for. It’s important to remember that should you fall behind with lease finance payments, assets could be repossessed. This is why it is vital all potential lessees understand the terms of the agreement in full.
How Does Lease Finance Work?
Lease financing works by transferring the ownership of an asset to the lessor for a period that equates to the working life of said asset. During this period, the asset is then rented (or leased) back to the lessee.
The rentals are structured to ensure at least the entire capital cost of the asset is repaid to the finance company through the initial term.
The key features of a finance lease are:
- The finance company purchases the goods
- The funding is secured against the equipment being financed
- You repay the finance company over an agreed term
- You pay VAT on each rental payment
You have an obligation to repay all these rentals with an end of contract balloon payment if outlined in the original contract. Once these have all been paid, the finance company will have recovered its investment in the asset.
At the end of the agreed period, you must return the asset to the finance company. In certain circumstances, some forms of finance lease allow for a second term once the primary term has expired. These are known as Minimum Term agreements (see below).
What are the different Finance Lease types?
The two basic forms of Finance Lease offered by asset finance companies are as follows:
At the end of the minimum term, the customer has the option of terminating & handing back the asset or continuing into a secondary period in return for a reduced or less frequent rental.
Rather than the ability for a lease to continue into a secondary period, a fixed term lease expires at the end of the term. The finance company then owns the equipment that cannot be sold to clients (but can be sold to a third party).
Who owns the asset and what happens at the end of the lease?
The customer does not own the asset at the end of the term (either primary or secondary).
What happens at the end of the lease varies depending on whether the lease is fixed term or minimum term. The following are possible options:
- Your business, acting on behalf of the finance company, sells the asset to a third party
- The asset is returned to the finance company to be sold
- Your business enters into a secondary lease period with the finance company
What are the benefits of a Finance Lease?
- The finance is secured against the equipment
- It is available on nearly all equipment purchases
- The finance spreads the cost of the purchase as many assets can be expensive to pay in a lump sum
- The VAT is spread so therefore not payable up front
- It is a tax efficient funding method*
Finance Leasing With White Oak
At White Oak, we offer a broad range of asset finance solutions that includes finance leasing and hire purchase. Designed to help businesses grow through investment in infrastructure and critical assets, spreading the costs over a fixed period is an incredibly powerful tool that can be harnessed to facilitate growth.