Types of Asset Finance
We can generally distinguish three major types of asset finance, or leasing: finance leasing, operating leasing and contract hire. Although strictly speaking not a type of leasing, we also include hire purchase:
Finance Leasing (Full Pay-out Lease)
You effectively acquire all financial benefits and risks accruing from use of the asset without acquiring the legal title. The leasing rate is computed to collect the full value of the asset (plus finance charges) during the contract period.
At the end of the lease, the asset is sold to a third party and you can receive a share of the sale proceeds (if the lease is not being extended). Generally, you will not be able to become the owner of the asset at any time unless a private arrangement is made with the third party. You will, however, usually have the option to extend the lease into a secondary period and as you will normally have paid for almost the full value during your initial lease period. The rental payments for subsequent periods will be minimal and are sometimes referred to as ‘peppercorn rental’.
Often with a shorter time frame than financial leasing (always significantly shorter than the working life of the asset), operating leasing is more like a regular rental. The lessor expects to be able to either sell the asset in the second-hand market or to lease it again and will therefore not need to recover the total asset value through lease payments.
There may be an option to extend the leasing period at the end (this negotiation can only take place at the end of the initial rental period). As with finance leases, you will not be able to become owner of the asset at any time but, contrary to financial leases, you will not share in the sale proceeds.
A form of operating lease (often used with cars and other vehicles) that includes additional services such as maintenance, management or replacement if asset is in repair.
This is an agreement for the hiring of an asset with an option to purchase. The legal title will pass to you when all payments have been made. The term of a hire purchase must be significantly shorter than the working life of the asset. You can claim capital allowances as if you have purchased the asset outright, gaining immediate use of it. Hire Purchase agreements are typically written for domestic users, not so much for business users.
Options at the end of the Lease period
At the end of the lease term you may be presented with a few various options. Lease contracts can stipulate that you:
- Return the asset.
- Have the right to act as an agent to sell the asset to an independent third party; and/or
- Can renew the contract or enter secondary periods.
It is important for you to anticipate your future needs as each option has its advantages and disadvantages and will affect your monthly payments both during the primary lease period and ongoing into any secondary period.