Asset Finance Explained – What is a Finance Lease?
12 December 2019
A lease is a contract between the finance company – known as the lessor, and you – known as the lessee.
The lessor purchases the asset from the supplier and then permits the lessee to hire the asset from the lessor in return for payment of rentals over a predetermined period for its use.
During the life of the lease the asset remains on your business’s balance sheet and rental payments pass through the profit & loss account.
For the life of the agreement, you are responsible for maintaining and insuring the asset together with other terms and conditions. The finance company may be able to repossess the goods if you fall behind with payments. You should read the terms of the lease carefully before entering into the agreement.
What is a Finance Lease?
This facility transfers substantially all the rights and obligations of ownership to the lessor for a period roughly equivalent to the useful life of the asset.
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, sometimes including a balloon payment at the end of the contract. Once these have all been paid, the finance company will have recovered its investment in the asset.
At the end of the period, you must return the asset to the finance company. In certain circumstances, some forms of Finance Lease provide for a period of hire to the lessor after expiry of the primary period known as the “secondary term”. 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 to WOUK or continuing with the hire of the asset 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, in a fixed term lease the lease expires at the end of the term. The finance company owns the equipment. It cannot be sold to client, but it 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*