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When you run a business, there are times when you need to make a purchase but may lack the funds to do so. Typically, you may consider a loan with your bank. However, there may be other options, such as a finance lease. As a business owner, it is helpful to understand the options open to you so that you can make the best financial decision for your circumstances. Therefore, this article will explain what a finance lease is and the benefits of this agreement.
A Lease
To better understand a finance lease, it is helpful to think about what a lease is in legal terms.
A Finance Lease
A finance lease also takes on the same legal meaning as a lease. However, it also has a commercial element, as a finance lease is a way to provide finance to another. Therefore, the lessor, such as a finance company, buys the fixed asset and lends it or leases it to the lessee or borrower during the lease term.
A fixed asset means an asset that is permanent and can generate revenue, such as:
- land;
- machines;
- buildings; and
- equipment.
With a finance lease, you, as the lessee, have ‘economic’ ownership of the asset during the lease agreement period. Accordingly, as the lessee, you bear any risks associated with the asset in line with the lease agreement terms. However, equally, you enjoy any rewards from the asset. This includes the ability to list the asset on your balance sheet as an asset with any remaining payments as a liability.
Some other terms used relating to finance leases are;
- conditional sale agreement;
- letter of credit;
- related reimbursement; and
- security agreement.
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Financial Arrangement
A finance lease is similar to a standard loan regarding the financial arrangement between the lessor and lessee. Rather than think of the loan as a sum of money, you may think of the loan as a fixed asset.
You, as the lessee, will pay the lessor the total price of the fixed asset. However, similar to a loan, you pay in instalments instead of paying it all at once. This is a type of rent for the use of the asset. During this repayment stage, the legal ownership of the asset remains with the lessor.
Just as a loan of a sum of money will incur interest, a finance lease will too, but in the form of a return on capital. You, as the lessee, pay this to the lessor. Once you have paid the total value of the fixed asset and the return capital, the fixed asset transfers to you, meaning you will have legal ownership.
Benefits
There are several benefits to a finance lease, including:
- regular set payments;
- if contract hire is unsuitable, a finance lease may be an option;
- little upfront costs;
- the rent is often deductible for the purposes of corporation tax;
- at the end of the lease arrangement, you can still use the asset, unlike with a contract hire;
- it provides a line of finance with no effect on existing banking arrangements; and
- occasionally, there is the ability to choose between a ‘fully amortising’ agreement or a ‘balloon payment’, so it offers flexibility to suit your needs.
Key Takeaways
A finance lease is where a lessor purchases a fixed asset and lends it to you as the lessee in return for regular payments. Whilst the lessor has legal ownership of the asset, you bear the risk and enjoy the rewards. The financial arrangement of finance leases can be either as ‘fully amortising’ or as a ‘balloon payment’.Once you have completed your payments or rent with the lessor and any sums formed as part of the agreement, you get to keep the asset. This means that you are the legal owner. Finance leases are beneficial for businesses because there are few upfront costs. Furthermore, you can include the rent payments you make as deductible for your cooperation tax.
If you need help understanding finance leases in the UK, LegalVision’s experienced leasing lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents for a low monthly fee. Call us today on 0808 196 8584 or visit our membership page.
Frequently Asked Questions
A finance lease is a type of loan. The lender or lessor buys a fixed asset, and you, as the lessee, use it in return for monthly payments. The asset is yours once you have completed all payments within the agreement.
There are numerous benefits to choosing a finance lease. For example, you get the asset at the end of your payments and have fixed monthly payments, so you have some certainty.
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