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How to Tell the Difference Between a Finance Lease and an Operating Lease

Submitted by diwakar on Tue, 12/12/2017 - 05:11
finance-lease-vs-operating-lease

The difference between vehicle lease types can be confusing concepts to understand at the best of times. However, by understanding these different types of leases we can start to remove the confusion around what can be valuable business tools.
 

So what is the difference between a finance lease and an operating lease?
 

Let’s break it down a little more.

 

Finance lease

Simply put, a finance lease is one way of providing finance on an asset that you intend to own at the end of the lease period. The lessor (owner) buys the asset for the lessee (hirer) and leases it to the lessee for an agreed lease period.
 

This means that, during the life of the lease, the lessee can use and account for the car as if it was their own property. The ultimate responsibilities of ownership may rest with the lessee.
 

The lessor charges a regular payment for use of the vehicle and retains legal ownership of the asset during the term of the lease and the lessee gets exclusive use of said asset (providing they abide by the terms of the lease).
 

The lessee will make fixed monthly payments during the term of the lease (which can include a full fleet management and maintenance package). The lease will have a specified and agreed residual value (sometimes called a balloon payment) at the end of the contract. This residual value is agreed to at the start of the lease and the lessor takes the risk as to whether the asset will maintain that value or not. A finance lease is for a contracted period and while it may be possible to terminate early it is likely that you would be asked to pay for all remaining rental payments for the full contract period.

 

At the end of the lease

There are different options available at the end of the contract which are typically:

– The lessee makes an offer to purchase the vehicle at the predetermined residual value (balloon)

– The asset is returned to the lessor and into a new lease period with a new vehicle*

– The lessee renegotiates the lease period

*If the asset is returned, the lessee may be eligible for a charge or a rebate, which generally equates to part of the sale amount (less the costs of disposal) as agreed in the lease contract.

 

Operating Lease

As opposed to a finance lease, a vehicle under an operating lease is always intended to be returned to the lessor at the end of the lease period.
 

The customer still gets the use of the asset over the agreed contract period in return for rental payments, but these payments do not cover the full capital cost of the asset and the customer is not entitled to retain the asset at the end of the lease period.
 

Operating leases can also include additional features such as a full maintenance package provided as part of the agreement. Full maintenance packages typically include roadside assistance in the case of accident or breakdown, scheduled and non-scheduled servicing, annual re-licensing & WOF when required. Maxxia will also manage your RUC usage and purchase additional RUC’s when you need them although the cost of these will be on-charged to you.
 

In an operating lease the lessor maintains ownership of the vehicle and the vehicle is handed back at the end of the contract.
 

The lessee may also elect to keep the asset and roll the lease on a month to month basis. Another option is for the lessee to enter into a revised contract for a further period. The regular payment amounts made in the second period can reduce significantly depending on how long the contract is extended for and how many kilometres the vehicle will travel.

 

Summary

The information above sets out some of the key information about operating and finance leases – in particular, the way in which a finance lease places substantially most of the risks and rewards to the lessee and with an operating lease, the risks & rewards remain with the lessor.
 

Clear as mud? Although the above information is general only, and is not tailored to your circumstances, we hope it has helped clear up some of the main points around operating and finances leases for you. Or, it may have generated another 50 questions, so get in touch if you want some more information about either lease option.

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