What Is a Leveraged Lease?
A leveraged lease is a lease agreement that involves financing through the lessor with the aid of a third-party financial institution. Essentially, an asset is rented using borrowed funds, making it an attractive option when funds are tight or asset ownership isn’t a long-term goal.
Understanding Leveraged Leases
Leveraged leases are often utilized for renting assets intended for short-term use. Common examples include cars, trucks, construction vehicles, and business equipment. Leasing an asset means a company or individual has temporary use rights, with possibilities of a buyout after the lease term ends.
The ’leveraged’ aspect signifies that funds to cover the asset’s high cost are borrowed. This leasing option is apt for entities lacking immediate funds but still requiring the asset. Instead of buying upfront, the lessee pays off the loan over the lease life, frequently at a lower amount than the full purchase price since it’s calculated for a specific rental period.
Leveraged Lease Structure
Leverage leases can be more intricate than standard operating leases due to the borrowed funds element. Terms depend significantly on the lessor’s financing relations. If the lessor is the financial institution itself, they approve the loan; if not, a third-party lender supplies the borrowed funds enabling quick possession of the asset post-loan approval.
Occasionally, a lessor might invest additional funds along with borrowed amounts from a third party to sweeten the lease terms. Regardless of structure, the lessee possesses the asset but typically doesn’t hold its title during the lease, and payments continue until the loan balance is fully covered. Usually backed by secured loans, devoid payments may lead the lessor to repossess the asset.
Leasing vs. Financing
Both leveraged leasing and financing are preferable routes for acquiring high-value assets such as cars. A leveraged lease includes a loan covering the estimated asset value for the lease period with potentially lower payments compared to full financing as it doesn’t cover the entire asset value.
Conversely, financing encompasses loans that cover the full asset value, similar to home loans, stretching repayment over longer periods.
Key Takeaways
- Leveraged leases enable an entity to rent an asset using borrowed funds for a determined period.
- They are suited for entities unable to outright purchase the asset or not intending long-term use.
- Referred to as capital leases in business accounting, these require specific accounting standards.
Special Considerations: Accounting for Leveraged Leases
Individuals may unconcerned with specific accounting rules but businesses must be meticulous. In business records, leveraged leases convert into capital leases based on criteria like lease life, purchase options, ownership transfer at the end, and present value of lease payments. Meeting any criterion it turns into a capital lease mandating asset purchase-like accounting; failing does otherwise.
Operating Lease vs. Leveraged/Capital Lease
An operating lease often bars options to buy rented assets seen majorly in apartment and building agreements. Leveraged/capital leases are noteworthy in business accounting due to distinct principles differentiating them from operating leases.
Related Terms: Lease, Lessor, Financial Institution, Capital Lease, Operating Lease, Financial Lease, Asset Management.
