Finance lease refers to that agreement where lessor buys the asset and transfers all rights and obligations relating to that asset to the lessee for which lessee pays a regular monthly rental to the lessor. In order to understand more about this concept, one should look at various important characteristics of finance lease –
Characteristics of Finance Lease
Two Parties
The first and foremost feature of a finance lease is that there are two parties involved in this agreement and there is no intermediary as agreement happens between the parties directly. While one party is called lessor who is the actual owner of the asset till the last rental of the asset is paid and other party is called lessee who is not the owner of the asset but he or she can use the asset by paying monthly rental to the owner of the asset who in this case is called lessor of the asset.
Transfer of Ownership
In case of a financial lease, the ownership of the asset get transferred to the lessee over the period of time and not immediately which is quite different from borrowing because in case of borrowing the ownership of the asset gets transferred immediately to the buyer of the asset even though he or she has not made full payment.
No Collateral Security and Margin Money
In case of financial lease, the lessee does not require to give collateral security to the lessor for taking the lease and he or she can use the asset immediately on paying the rental to the lessor besides one does not need to give margin money upfront which is the case with borrowings done through banks and financial institutions.
Lease Term
Lease term in case of a finance lease is long and the lessee can use the asset for the full economic life of an asset which is not the case with an operating lease which is a short period concept.
Repair and Maintenance Charges
In case of this lease, all costs associated with repair and maintenance related to the leased asset is borne by the lessee as the lessee is using the asset and lessor has transferred all risks and rewards associated with the asset under question.
Option to Buy the Asset
In case of a financial lease, the lease agreement gives the lessee a bargain option using which the lessee can buy the asset at a discounted price to market price near the end of the lease term of the asset.
As one can see from the above that financial lease is quite unique and different from other forms of borrowing and that is the reason why if you are one of those people who is looking to use this mode of financing for purchase of asset than you should read above characteristics carefully and then decide whether to use this method of financing or not.