What is a finance lease for businesses?
A finance lease is a type of equipment finance that gives a business full use of an asset and the benefits of ownership, in return for regular lease payments. The lender purchases the asset on your behalf and retains ownership of the asset until the end of the lease.
A finance lease is generally used for long-term high-value assets — e.g. company vehicles, medical equipment or heavy machinery — and provides greater owner benefits for a borrower than an operating lease.
A finance lease will often have lower interest rates than other types of equipment finance. This is because the borrower takes on responsibility for maintaining the asset during the lease.
Finance lease overview
- Generally suitable for high-value assets or assets with a longer lifespan, like company vehicles, heavy machinery and specialised equipment
- Repayments are fixed over the lease term
- The borrower is responsible for all associated costs with owning and using the asset during the lease
- The lender retains ownership the asset but the borrower has the option to take ownership at the end of the lease term
- A balloon/residual option for the lessee to purchase the property or equipment and take ownership of it at a specific price
- The asset is listed on the business’s balance sheet. Lease payments are listed on profit and loss statements. Payments are generally tax-deductible
The main benefit of a finance lease over other forms of business finance is flexibility at the end of the lease term. In general, the cost of the asset will be spread across the lease repayments, with the option to make a final payment to own the asset outright (known as the residual amount). The residual payment is set by the lender at the start of the contract.
At the end of the lease, you’ll have the option to purchase the asset and assume full ownership. If the asset is worth more than the residual, the business will profit from the purchase.
If taking on ownership of the asset at the end of the lease, depending on the agreement, you may have the option ti simply end the lease and return the asset. With a business loan, like a chattel mortgage or truck loan, that will not be an option.
Pros & cons of a finance lease
Pros
- Generally offers ownership at the end of the lease
- Doesn’t require a deposit or security — other than the asset financed
- Immediate access to your business equipment once purchased
- Repayments may be tax-deductible
- Rental payments can be tailored over the term of the agreement
Cons
- You are responsible for asset maintenance and running costs
- Responsible for repairs and damage
- It may be difficult (and expensive) to cancel a finance lease before the lease term ends
Choose the right type of lease
Shaun McGowan, Loans Expert
Both an operating lease and a finance lease allow a business to access business equipment through regular finance repayments. The main difference is in ownership at the end of the lease term. A finance lease will allow a borrower to take ownership of the asset, whereas an operating lease generally will not.
Shaun McGowan, Loans Expert
How a finance lease works
The lender will purchase the asset on behalf of the customer, who then pays the lender a fixed monthly lease rental — plus interest — for the term of the lease. At the end of the lease, the asset is often purchased by the business at an agreed price, or returned to the lender.
The asset is listed on the business’s balance sheet, and lease repayments to the lender are generally tax-deductible. A finance lease uses fixed-rate payments, which ensures that repayments will stay the same regardless of changes to interest rates.
However, as the business takes full responsibility for the asset, it will also need to consider any additional costs such as repairs, maintenance, or servicing.
With a finance lease, you’ll pay close to the full value of the asset over the agreed term. Your lender will decide at the start of the contract how much they expect the asset to be worth by the end, and your final payment will be based on that anticipated value.
When do businesses use a finance lease?
A finance lease is often used for high-value assets where the borrower intends to take ownership of at the end of the lease. Or at lease wants the option to take ownership.
Many borrowers we work with use a finance lease to acquire a business vehicle fleet. But I've also seen it used commonly for assets like medical equipment and heavy building machinery.
Using a finance lease to purchase an expensive asset (instead of paying with cash) means the business maintains operating cash flow and working capital. Residual payments are set at the start of a lease, which means a business can also profit if the asset’s value is higher than initially assessed.
Finance lease example
A plumbing company, Unreal Plumbing, is looking to hire two new plumbers and needs vehicles for them. These new hires will generate revenue over time, but currently the business doesn't have sufficient cash to purchase the vehicles outright. However, the business owner does want the option to own these new assets eventually, assuming the growth ambitions are realised as planned:
- Unreal Plumbing acquires two new utes valued at $120,000 through a finance lease
- The business has full use of the assets which are included on the balance sheet
- The business makes regular lease repayments for a 5-year term
- The lease agreement includes an option to pay the residual value of the vehicles ($20,000 each) at the end of the term, in which case the business would own the utes outright
- Based on the advice of the business' accountant, the lease payments are tax deductible and the business can claim the GST paid as an input credit on its Business Activity Statement.
How to qualify for a finance lease
Eligibility for a finance lease is assessed in the same way as other equipment finance applications. That means the applicant must be:
- An Australian citizen or permanent resident
- A business with an ABN and GST registration
- A business that has been operating for at least 6-12 months
- Able to provide business bank statements to demonstrate capacity to make the lease payments based on revenue
Applying for a finance lease
You can apply for an operating lease with:
- Banks
- Finance brokers
- Non-bank lenders
- Specialist asset finance lenders
The speed of approval for your application will depend on the type of asset you wish to finance, the value of those assets and how long you have been in business (established business may receive faster approval).
Because the lender will actually be purchasing the asset on your behalf, the process will likely take longer than other types of short term business finance, such as an unsecured business loan. Business who need fast access to capital could also consider a revolving line of credit in the form of a business overdraft.
However, interest rates on these shorter-term credit facilities will likely be higher.
Finance lease rates
Finance lease interest rates will vary between lenders. However, they will generally be lower than those on operating leases and unsecured business loans. This is due to the value of the assets available under this lease option, which can serve as collateral on the loan amount.
Your personal and business financials will be taken into account when assessing your application (for example, the lender may check your credit score), along with the type of asset you wish to finance and its age.
Finance lease interest rates in Australia
| Lowest average rate | Average rate for machinery |
|---|---|
From 4.49% | From 5.00% |
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