Finance leases: definition
A finance lease is a type of equipment lease where the customer (or 'lessee') rents an asset for most of the item's useful life. Finance leases are sometimes also known as capital leases.
Finance leases explained
One key feature of finance leases is that the customer takes on most of the risks and rewards of ownership (i.e. maintenance costs and fluctuations in value), but never actually owns the asset.
What this means in practice is that a finance lease looks and feels a lot like hire purchase, but they're different on the balance sheet.
How do finance leases work?
Finance leases consist of a primary rental period, where the monthly payments will add up to the full cost of the asset plus interest (hence their other name, capital leases).
Once the primary period is up, the asset will normally be near the end of its useful life. At the end of the primary lease period, you will usually have three options:
- Continue to use the asset in a secondary lease period (often with cheaper payments)
- Sell the asset and keep a share of income from the sale
- Return the asset to the lessor