Small businesses need to understand how finance leases work, what risks are involved, and whether or not they’re the right choice for your business.
Finance leases are essentially just like hire-purchase agreements, except they use the asset you’re purchasing as security for your lease.For example, suppose you want to purchase a car with a finance lease. In that case, the vehicle will serve as security during the term of your agreement.
What is a Finance Lease?
Essentially, a finance lease is when you use an asset as security for your loan.
Like hire-purchase agreements, a finance lease intends to reduce the initial costs associated with purchasing expensive assets with high depreciation rates or low resale values.
The three types of finance leases are operating, capital, and combined leases.
1. Operating Lease
It is the most common form of finance lease available to small businesses. In an operating lease, you have a monthly rental payment that covers your use of the asset in question, plus any associated fees.The main difference between this type of lease and a hire-purchase agreement is that operating leases are generally excluded from tax deductions.
Operating leases pose no risk to the lessee (you). Still, there is always a chance that you’ll lose out financially if you can’t meet your monthly rental payment.
2. Capital Lease
A capital lease essentially acts as a combination of a finance lease and a loan because the lessee acquires an asset while simultaneously having its finance.
Capital leases can have very flexible terms, especially when compared to other finance leases. In addition, some capital leases allow the lessee to make early payments without incurring any penalties.The main advantage of a capital lease is that it offers small businesses complete ownership of an asset after their contract.
3. Combined Lease
This type of finance lease combines features from both operating and capital leases. For example, you can use your asset as security for your loan while still retaining your asset ownership at the end of your contract.
This type of finance lease is often called a ‘walk away’ agreement. It is because you can walk away without additional costs if you cannot meet any financial obligations.It is the only type of finance lease that allows for early repayment without incurring penalties.
How do I Apply for a Finance Lease?
The application process for a finance lease can be lengthy and complicated. Still, you’re likely to face fewer hoops to jump through if your business has a good credit history.
Your ability to secure a finance lease will depend on these factors:
-If you currently hold another type of finance arrangement (such as hire-purchase)
-How much capital do you have to place as security
-Whether or not you’re willing to offer additional security for your lease and the age of the assets involved.
Once you’ve determined that a finance lease is right for your business, start looking for an approved lessee. It may require you to visit several financial institutions before finding one that’s willing to work with you.
According to Lantern by SoFi, “Not all loans come with a prepayment penalty.” So if you want to know the pros and cons of paying off a car loan early, give them a call.