What Is A Finance Lease?

Buying a car on a finance lease is an option for business owners instead of taking out a loan or paying for the car upfront.  Finance leases tend to be more popular with larger companies running a sizeable fleet, with most small businesses and sole traders choosing a Chattel Mortgage.

Read on to find out everything you need to know about the different types of car finance leases you can get in Australia, including answers to FAQs.

 

How does a finance lease work?

A finance lease basically gives you all the benefits of owning a car without actually owning it. You get to use the car for the term of the agreement in return for making monthly payments. At the end of the lease, you usually have four options:

1) upgrade the car and take out a new finance agreement.

2) buy the car by making a larger final payment (called a residual or balloon payment). The amount of the residual or balloon payment will depend on the terms of your agreement.

3) give the car back and walk away.

4) refinance and extend the lease.

 

Advantages of lease financing

There are several advantages of lease financing.

  • It allows you to use a new car with access to a new car warranty.
  • You don’t have to come up with a lump sum to buy your car upfront.
  • You have the flexibility to buy, upgrade or walk away from your car at the end of the lease term. Most companies choose to upgrade and keep running newer vehicles.
  • You can choose a term to suit your business cash flow.

For example, if you want to lower your repayments, you can choose a longer term (and vice versa).

  • You can budget for your fixed monthly repayments. Finance leases usually have a fixed interest rate for the entire term.
  • You can claim a credit for the GST on your payments to lower the amount of GST your business has to pay.
  • Vehicle depreciation, interest and running expenses are tax-deductible for finance and operating leases.

 

Disadvantages of a Finance Lease

  • The deemed ‘market value’ of the car is often set unrealistically high at the end of the lease term. That means you can be well out of pocket if you want to keep the car, otherwise you’ll often end up upgrading to another car -paying the high finance costs all over again.
  • Flexibility comes at a cost! Often the total lifecycle cost of running a new vehicle fleet under finance leases can be higher than other forms of finance.
  • Interest costs and other charges aren’t always clear. Interest, monthly account keeping, insurance.. these costs are often buried within a finance lease agreement and can be very high.
  • Often the company providing the lease is the same company providing the vehicle, meaning you have no room to negotiate on the car price.

 

Finance lease examples

Jim is a small business owner who wants to buy a new vehicle. He decides to take out a finance lease on the following terms.

  • Amount $40,000
  • Term: 4 years
  • Monthly repayment: $543.92
  • Residual payment: $20,000

At the end of the 4-year term, Jim could decide whether or not he wanted to keep the vehicle.

If he wanted to lower his monthly repayments, he could either increase his term or his residual payment amount, as the below calculations show.

Increased term

  • Amount $40,000
  • Term: 5 years
  • Monthly repayment: $460.76
  • Residual payment: $20,000

Increased residual payment:

  • Amount $40,000
  • Term: 4 years
  • Monthly repayment: $387.24
  • Residual payment: $25,000

 

What is a finance lease obligation?

A finance lease ‘obligation’ is legal jargon for the financial payments you need to make under the terms of your agreement. For a car finance lease, these payments include regular monthly repayments, as well as any residual (end of agreement) payment amount.

 

Finance lease definition

A car finance lease is a legal arrangement, so here is the legal explanation. It involves two parties – a lessor and a lessee. The lessor is the owner of the car and the lessee has the right to use the car for the term of the agreement in return for making regular payments.

 

What is a finance lease agreement?

A car finance lease agreement is a legal contract between the car owner (usually a finance company) and the car user. There are 3 main types of leases in Australia.

1) finance

2) operating

3) novated

 

The differences between an operating lease and a finance lease

As the name suggests, operating lease payments only cover a business vehicle’s operating costs. Operating costs include registration, tyres, insurance and servicing.  At the end of the agreement term, the car is simply handed back to the vehicle owner (the finance company).

Operating leases are like prolonged car rental agreements you might get through companies like Hertz and Avis, but usually for medium to long term requirements. They also tend to have shorter terms than finance leases (usually over 3 years).

Operating Leases are less popular these days because any operating lease for a term of over 12 months need to be reported on the lessor’s balance sheet.

 

Finance lease vs operating lease

Finance leases give you the option to buy the vehicle at the end of the agreement term. Operating leases don’t give you that option.

Payments on a finance agreement don’t cover operating costs. They help to cover the purchase price of the vehicle instead.

 

The difference between a novated lease and a finance lease

A novated lease is a salary sacrificing arrangement between an employer and employee. The key difference is that the employee makes the regular payments rather than the business.

An employee usually has the same 4 options at the end of a novated lease as a business has at the end of a finance agreement, namely:

1) upgrade the car and take out a new agreement.

2) buy the car by making a larger final payment (called a residual or balloon payment). The amount of the residual or balloon payment will depend on the terms of the agreement.

3) give the car back and walk away.

4) refinance and extend the agreement.

Novated leases are often NOT the cheapest option for an employee, see our article on the hidden costs of novated leases.

 

Is a finance lease an asset?

Yes, a vehicle on a finance lease must be listed as an asset and a liability on your business balance sheet. The old days of ‘Off Balance Sheet Financing’ no longer apply!

Prior to January 1, 2019, operating leases were not required to be listed on your balance sheet as an asset, but they now are.

Novated leases do not appear on the business balance sheet because they are arrangements made on behalf of employees.

 

Other FAQS

Which is better, a finance lease or an operating lease?

This depends on your business needs and financial situation. Finance agreements may be a better option for you if:

  • you want to keep the vehicle for over 12 months.
  • you don’t mind paying for the car’s running costs separately.
  • you may want the option to own the vehicle at the end of the agreement term.

(You should also consider a Chattel Mortgage)

On the other hand, an operating lease may be a better option for you if:

  • you want to keep the vehicle for a shorter time.
  • you don’t want the option to own the vehicle at the end of the agreement term.
  • you want lower payments (as the vehicle purchase price isn’t included in the regular payments).

 

What are the interest rates on car leases?

Different lenders/finance companies will charge different interest rates. Typically interest rates on leases are higher than other forms of finance.  If you have a good credit score, you will usually be able to get a cheaper rate than if you have bad credit.

How often do you make car finance lease payments?

Standard payments are monthly, but many finance companies will allow you to make weekly or fortnightly ones if you prefer. You should align your vehicle payments with your business cash flow.

 

How we can help

If you’re looking to buy a new car on a finance lease, talk to our expert brokers at Auto Car Loans.  We’ll take the time to understand your business situation before finding you a great deal.

Don’t waste your time trying to find a great deal yourself or let yourself get talked into dealer finance at a car yard. If you do, you’ll end up paying more. We work for our car buying clients, not for lenders or dealers.

We arrange vehicle finance for a living from a panel of over 50 lenders. We will also help you with your loan application paperwork.

Get in touch with one of our experienced finance brokers today by calling 1300 301 051 during business hours.

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