Finance Leasing Manual - FLM1.16

Example of how a finance lease resembles a loan

A simple example may help illustrate how a finance lease resembles a loan.

A trader who wants an asset costing £1,000 could borrow £1,000 at 10% from a bank and use the money to buy the asset. The trader will pay the bank the interest and also repay the capital. The capital could either be repaid in one lump sum at the end of the loan period or it could be structured like a repayment mortgage, with small capital payments and large interest payments at first and, towards the end, large capital payments and small interest payments.

The same commercial result can be achieved with a finance lease. The finance lessor (often a subsidiary of a bank) buys the asset for £1,000 and leases it to the lessee. The lessee is the one who uses the asset. The lessor charges the lessee rentals which, over the term of the lease, will repay the capital with a commercial rate of 'interest'.

The 'interest' charges included in a finance lease agreement may fluctuate with base rate or with other changes (such as tax rate or régime changes) and so there will often be provisions in the lease which spell out the consequences. Usually, the aim is to leave the finance lessor making its desired turn on the finance whatever happens: the lessee picks up any increased costs and benefits from any reduced costs.