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How does an Operating Lease work?
An operating lease can also be referred to as contract hire. Operating leases allow an asset (normally a vehicle) to be leased over a fixed term with an agreed annual kilometre usage for a set payment (rental). There is a residual value (balloon payment) at the end of the lease. This is an amount that is offset until the end of the term which has the effect of reducing your regular lease payments (rentals). The lessor (normally a bank or finance company) retains ownership of the asset while the lessee (you, the user) effectively just hires it for a period of time.
At the end of the lease period you can choose to return the asset, continue the lease or purchase the asset. You are not liable for the residual value, the owners carry this risk. That means that you can simply hand the vehicle back at the end of the term and start again.
Operating leases are also available as fully maintained leases. With a fully maintained lease your lease payment includes all scheduled servicing and maintenance costs, such as repairs, registration renewal and tyres.
The amount financed is GST exclusive. GST is charged on the lease payment and the residual value at the end of the lease. If you are registered for GST, you can generally claim some or all of the GST contained in the lease rental and the residual value as an Input Tax Credit on your next Business Activity Statement.*
You can generally claim the lease payments as tax deductions if the amount financed is below the depreciation limit. If the amount financed is above the depreciation limit then you can claim interest charges on the lease and depreciation, up to the value of the depreciation limit.*
With operating lease the asset is not shown on your balance sheet.
Who does an Operating Lease suit?
An operating lease is suitable when the asset will be used for predominantly (50%+) business purposes. The product is mainly used by ABN holders – companies, sole traders, trusts and partnerships.
Before you buy or lease a second-hand asset you can check to see if the owner has ‘clear title’ or if there is a registered interest in it by doing a PPSR (Personal Property Securities Register) check to protect yourself against potential repossession.
The Personal Property Securities Register is the register where details of security interests in personal property can be registered and searched. The Australian Financial Security Authority (AFSA) is the Australian Government agency responsible for administering the PPSR. You can visit their website at www.ppsr.gov.au .
For used cars you can also arrange checks through other service providers to see whether the asset has ever been an insurance write-off or stolen and if the vehicle has suffered from flood or water damage.
The Key Factors
Finding the best operating lease for you will depend on your individual circumstances but the main factors to consider are:
Interest Rate – The rate of interest plays a large part in determining your repayment amount. The higher the interest rate the higher the repayment amount. But you need to be aware that the interest rate isn’t the only factor that will effect the total cost of your lease.
Fixed and Variable Rates – The interest rate is usually fixed, meaning that it will remain the same for the life of the operating lease, but it can also be variable. If the interest rate is variable this means that it can change during the time that you have the lease. Variable rates can be linked to the rate of interest that the lender is paying for its money in the same way that a lot of home loans are. So generally speaking if you have a variable rate and the Reserve Bank increases interest rates your interest rate and repayment amount will increase. If the interest rate is fixed you know exactly how much your lease payments are going to be for as long as you have the lease and you can budget around them accordingly.
Fees – Some banks and finance companies will allow you to include various fees within your operating lease while with others you will have to pay them separately. Usual fees include, establishment fees, which are one off amounts charged by the lessor (bank, finance company) for accepting and setting up your lease. Make sure that you are aware of all the fees associated with your lease and make sure that they are included within the repayment amount that you are quoted.
Lease Term – Lessors have minimum and maximum periods for repaying the operating lease. Depending on the type and age of asset the minimum lease term is usually 1 year with the maximum usually being 5 years (less for some assets and older second-hand assets). The term of the operating lease is another significant factor in determining what your repayment amount will be. The shorter the term the higher the lease payment, and the longer the term the lower the lease payment. But remember the longer the term the more interest you will be charged and the more you will pay back in total.
Deposit – You do not pay a deposit on a lease but you may be able to pay advance payments (rentals) which will reduce your regular lease payment.
Total Amount Payable – This is the total amount that you pay back to the lessor for your lease.
Additional Repayments and Early Termination – Generally leases operate over fixed terms at fixed lease payments and you are unable to make additional repayments into your lease. If making extra payments and paying off your finance early is important to you then make sure to check that your finance allows you to do this and any costs associated with doing this are acceptable to you.
Minimum and Maximum Lease Amounts – Normally the lowest lease amount available from mainstream lenders is $5,000 or $10,000. The maximum varies from lender to lender but $100,000 to $150,000 is the most that many lessors will provide for a lease agreement.
Residual Value (Balloon Payment) – A residual value amount, often referred to as a balloon payment, is applied to the operating lease. This is an amount of the lease that is offset until the end of the lease term which has the effect of reducing your regular repayments. Be aware that whilst you do not make principal repayments on the residual value amount you will be charged interest on it. At the end of the lease term you can to return the asset, continue the lease or purchase the asset. You are not liable for the residual value, the owners carry this risk. That means that you can simply hand the vehicle back at the end of the term and start again.
Lower Interest Rate – By using the asset that you’re buying as collateral the lender has increased security and as a result can offer you a lower rate of interest, which means lower repayments for you.
Potential Tax Benefits* – Under an operating lease GST is charged on the lease payment and the residual value at the end of the lease. If you are registered for GST, you can generally claim some or all of the GST contained in the lease rental and the residual value as an Input Tax Credit on your next Business Activity Statement. You can generally claim the lease payments as tax deductions if the amount financed is below the depreciation limit. If the amount financed is above the depreciation limit then you can claim interest charges on the lease and depreciation, up to the value of the depreciation limit. The asset is not shown on your balance sheet
No Capital Outlay – You can get the asset that you need for your business with zero or minimal outlay, so any capital that you do have can be used for other things.
Effective Cashflow – By financing the GST exclusive price and including a residual value (balloon payment) at the end of your lease this reduces your repayment and frees up more cash.
Inclusions – You can potentially include things like government fees, insurance premiums and accessories as part of your lease, so one repayment covers all of your costs.
Budgeting – You can opt to include all scheduled servicing and maintenance costs, such as repairs, registration renewal and tyres in your lease, which can assist you to budget costs more effectively.
Costs – Any type of borrowing is going to cost you money and a lease agreement is no different. But don’t forget using your own money comes with its own costs too. Just think of the return that you could you get if you invested the funds in your business or interest that you would generate if you invested the money. You just need to make sure that you do your research and get the best the lease for you.
Security – Although using your asset as security can help to get you a lower interest rate it also means that if you don’t make your agreed payments you risk the asset being repossessed.
Personal Use – If you’re using the vehicle for predominantly personal purposes then an operating lease agreement is not the most effective option for you.
Asset Only – With an operating lease the amount that you finance can only be used for the purpose of leasing the asset. You can’t split the funds and use part for the asset and part for something else.
Fees – If you opt for a fully maintained operating lease then there can be additional fees to pay for the administration of the maintenance costs.
Equity – There is little opportunity to build any equity in the asset as the main purpose of the product is to enable the user to simply hire the asset over a set period and then hand it back.
Charges – You may incur charges if you hand back the asset and you have exceeded your agreed kilometres or it is not in what the lessor regards to be reasonable condition.
Things to Consider
Payment Frequency – Most lenders will give you the option of making weekly, fortnightly or monthly repayments. Choose the frequency that will help you to budget best.
Your Current and Future Circumstances – Think about what your requirements are right now but also your plans for the future. For example, if you’re planning other expenses and your business’s income is going to reduce whilst you have your lease agreement, ask yourself if you would still be able to make the repayments. Maybe you need to look at a lease over a longer term to reduce your repayment. If you expect that your income will increase during the time that you’re paying your lease off consider what lease term is most suitable and whether it is the best finance method for you.
Rate for Risk – Some lenders use a system whereby they determine the rate that they offer to you based on their analysis of your profile. This includes your credit history and business history as well as what asset you are buying. The better they deem your profile to be the lower the rate you will get.
Equity – Are you looking to build some equity in the asset by the end of the finance term or would you prefer to have the ability to hand back the asset and start over again?
LoanPlace.com.au is here to help you make sense of it all by providing you with information resources and connecting you with experienced professionals who will search their lenders to find the latest deals so that you get 3 Free Quotes to evaluate and compare.
*We strongly recommend that you consult your accountant or tax advisor to confirm the tax benefits available to you prior to entering into any finance agreement. The information provided is for product description purposes and is not intended to be used as taxation, financial or legal advice.