Lease financing is a significant medium to long-term, finance solution. The owner of the assets- “the Lessor” gives another person – “the Lessee,” the right to use the asset for a regular (usually monthly) payment.
Assets such as vehicles, equipment or software are popular items attracting lease finance.
The payment, known as lease rental, allows the lessee to use the asset, which remains the possession of the Lessor for the contract period.
At the end of the period, the Lessee either returns the asset, takes up the option to purchase at a new residual price, or, enter into a new lease agreement.
The cost of lease finance is often a lot less than the cost of bank funding.
How does it work?
Finance leasing allows the Lessee to take the asset with risks and rewards attached to the property on the same basis as an owner.
The lease is generally non-cancellable for a fixed period, during which time the Lessor can recover total investment through lease rental (periodical payments).
The “secondary period” is shorter, and the repayments are less, often called the peppercorn payment or rent.
Where does it work?
Lease finance is favored by small business enterprises (SME), and individuals, where cash flow is the lifeblood of the firm. A monthly payment, even with interest attached, is often the better option than using cash to purchase capital items. It allows the lessee to purchase an expensive item or capitalize the business over a period, thus alleviating the necessity of finding a significant amount of upfront cash.
Pros and Cons of Lease Finance
- A lease contract is often worked over a longer period than a bank loan
- Cash Flow for business, especially a start-up will not be affected by massive outlay for CapEx
- Lease payments are tax deductible business expense
- It is easier to get leasing finance with poor credit rating
- Leasing terms are lower than using another form of capital financing
- Lease companies offer flexible terms, such as closed end and open end leases, and balloon payments, etc.
- Leasing, whether it is a car or equipment doesn’t allow for equity build up and is often more expensive over time.
- Monthly payments have to continue to be made (according to the initial contract period), and there is always a substantial early settlement charge involved, even if the asset is no longer in use!
- Reading the “contract fine print” is of vital importance. Lessees must make themselves fully aware of all the terms and conditions regarding insurance legislation, repairs and maintenance and the most important of all, ‘who actually owns the asset and who owns the lease.’ Often these are two separate companies.
- Confusion and ignorance are not an option. Make yourself fully aware of your rights.