Difference Between Finance and Operating Lease

Compliant Funding Solutions

When it comes to determining the most appropriate equipment leasing strategy for your school, understanding the main differences between a finance lease and an operating lease is essential. In both cases, the equipment is legally owned by the lessor, with rentals paid by the school in order to use the equipment.

It’s important to note that, an operating lease is the only type of lease agreement that state funded schools (local authority or Academy) can enter into without prior approval from the ESFA.

There are however key differences that you need to know about and this article outlines those.

Prefer to watch? Here’s a short explainer video :

What is a finance lease?

A finance lease is a way of providing finance – effectively a leasing company (the lessor or owner) buys the asset for the user (usually called the hirer or lessee) and rents it to them for an agreed period. The lessor charges a rent for hiring the asset to the lessee.  The lessor retains ownership of the asset but the lessee gets exclusive use of the asset (providing it observes the terms of the lease).

The lessee will make rental payments that cover the original cost of the asset plus interest costs, during the lease.  Once these have all been paid, the lessor will have recovered its investment in the asset.

Operating lease

In contrast to a finance lease, an operating lease does not transfer substantially all of the risks and rewards of ownership to the lessee.  It will generally run for less than the full economic life of the asset and the lessor would expect the asset to have a resale value at the end of the lease period – known as the residual value.

This residual value is forecast at the start of the lease and the lessor takes the risk that the asset will achieve this residual value or not when the contract comes to an end.

The customer gets the use of the asset over the agreed contract period in return for rental payments.  These payments do not cover the full cost of the asset as is the case in a finance lease.

Ownership of the asset remains with the lessor and the asset will either be returned at the end of the lease, when the leasing company will either re-lease, or sell it to release the residual value.   Or the lessee can continue to rent the asset at a fair market rent which would be agreed at the time.  With an operating lease there is no option for the customer to take title at the end of the Lease.

Contact our team of experts to find out more about how our operating leases can help your organization.

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