What is a Finance Lease?

A finance lease is a popular form of asset finance. It involves a contract between a finance company (the lessor) and a borrower (the lessee). The lessor buys an asset from a supplier and leases it to the lessee, who then makes payments over a predetermined period.

The lease agreement sets out strict terms and conditions at the beginning. These include responsibilities for asset maintenance and insurance, which the lessee must manage. Missing lease payments can lead to asset repossession by the lessor.

The difference between leasing and financing

One of the primary questions businesses have when looking at asset finance is whether to lease or finance an asset. While both options allow you to access equipment or machinery without a large upfront payment, the key difference lies in ownership.

• Leasing allows businesses to use assets over an agreed period without taking on ownership. At the end of the lease, businesses can either continue the lease, return the asset or sometimes even purchase it for a lump sum. This gives businesses flexibility without the burden of owning the asset outright, making it ideal for assets that may become obsolete or less valuable over time.
• Financing, on the other hand, typically involves securing a loan to purchase the asset, with the asset acting as collateral. In this case, businesses take ownership right away, but they must manage the risks associated with ownership, such as depreciation and maintenance. Financing is suitable for companies who plan to keep the asset on a long term basis.

How does lease finance work?

Lease financing involves transferring ownership of an asset to the lessor for a period that matches the asset’s useful life. During this time, the lessee rents the asset back.

The structure of rental payments ensures that the finance company recovers the entire capital cost of the asset within the initial term.

Key features of a finance lease include:

• The finance company purchases the equipment.
• Funding is secured against the equipment.
• You repay the finance company over an agreed term.
• VAT applies to each rental payment.

You need to repay all rentals, including any end-of-contract balloon payment specified in the original contract. Once you have made these payments, the finance company recovers its investment in the asset.

At the end of the agreed period, you must return the asset to the finance company. Some finance leases, known as Minimum Term agreements, offer the option to extend into a secondary term (see below).

What are the different types of finance leases?

Asset finance companies offer two main types of finance leases:

• Minimum Term: At the end of the minimum term, you can terminate the lease, return the asset or enter a secondary period with reduced or less frequent payments.
• Fixed Term: A fixed-term lease ends at the conclusion of the term. A finance company retains ownership of the equipment, which cannot be sold to clients but may 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 either the primary or secondary term. At the end of the lease, you have several options:

• Sell the asset to a third party on behalf of the finance company.
• Return the asset to the finance company for resale.
• Enter a secondary lease period with the finance company.

What are the benefits of a finance lease?

• The finance is secured against the equipment.
• Available for nearly all equipment purchases.
• Spreads the cost of the purchase, avoiding a large lump sum payment.
• VAT is spread out, avoiding an upfront payment.
• Provides a tax-efficient funding method.

An important factor to consider when entering a finance lease is the depreciation of the asset. All assets, whether vehicles, machinery or equipment, lose value over time. This reduction in value is known as depreciation, and it plays a significant role in determining the overall cost of leasing.

In a finance lease, the monthly payments often reflect the depreciation of the asset. For example, if the equipment originally costs £50,000 and is expected to lose 75% of its value over the course of the lease term, the payments will typically cover the asset’s depreciation, plus some additional amount to ensure the lessor receives a return on investment.

Understanding depreciation is crucial for budgeting and planning. As the asset’s value declines, your business’s lease payments will help offset this loss. Some leases may also include an optional final balloon payment, which accounts for the remaining value of the asset at the end of the lease term. This flexibility allows you to make decisions based on the asset’s condition and usefulness once the lease ends.

Finance leasing with White Oak UK

At White Oak UK, we offer a broad range of asset finance solutions, including finance leasing and hire purchase. Our services support business growth by enabling investment in infrastructure and critical assets. Spreading the costs over a fixed period is a powerful tool to facilitate your business’s expansion.

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If you are looking to find the right finance for your business, contact us today.

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