Financial Leasing versus a Bank Loan
When investing, a Bank Loan and a Financial Lease are among the most important financial credit methods used by companies, especially industrial and construction firms. What are the main differences between these two financing methods (financial lease and bank loan)?
- CONTRACT'S SUBJECT:
- The subject of a BANK LOAN is usually money, but sometimes the borrower does not use the money for the purpose for which the bank lent it for.
- The subject of a FINANCIAL LEASE could be movable or immovable assets, but it cannot be cash money. So the lessee is obligated to use the asset according to the purpose in which it is allocated and maintain it, especially since she/he does not own the asset yet.
- Ownership of the money in a BANK LOAN is transferred to the borrower as soon as the contract is signed.
- In a FINANCIAL LEASE, ownership of the asset is typically not transferred to the lessee, because she/he has the right of choice to extend the contract or return the asset to the lessor. However, if the lessee chooses to buy the asset at the end of the contract's period, the ownership of the asset is transferred to her/him from the date of declaration of her/his desire to do so.
- EXTENT OF FUNDING:
- Bank financing in a BANK LOAN is limited to a portion of the total value the borrower is needing, which normally ranges between 60% and 70% of that value. This is because the lender bank want to ensure the seriousness of the borrower by bearing a part of the financing burden. In addition, it often requires that the borrower provides guarantees (in-kind and/or personal) to ensure payment of the debt.
- In FINANCIAL LEASING, the lessee is 100% financed, because the financing is in kind, not in cash. In addition, the financial leasing company maintains the ownership of the asset (the subject of the contract) as a guarantee to fulfill the obligations of the lessee, and thus it reduces or prevents the request of other guarantees in kind or personal.
- AFFECTING CREDIT CAPACITY:
- As a result of a BANK LOAN, the borrower's creditworthiness is affected (diminished), because from an accounting aspect the loan enters her/his balance sheet on the side of the liabilities and appears as a debt. In addition to that banks establish a maximum borrowing limit for the company, which restricts future borrowing.
- The burdens resulting from paying the rental fee in a FINANCIAL LEASE is recorded as a purchase/sale on the balance sheet as both an asset and a related liability, which gives a better image to the lessee's balance sheet and increases the possibility of obtaining some other financing.
- END OF THE CONTRACT:
- By the end of a BANK LOAN contract, the borrower has to return (pay) the full loan amount to the lender.
- At the end of a FINANCIAL LEASE contract, the lessee can choose to return the asset to the leasing company, and therefore the lessee has paid the rental fee and returns the asset to the lessor.
- RATE STRUCTURE:
- Banks in a BANK LOAN seek to offer a long-term loan with a variable rate, which makes the rate risk on the borrower instead of the bank.
- In FINANCIAL LEASING, the lessor and the lessee agree on a fixed rate for the term of the contract.
- ACCOMPANYING COSTS:
- Banks in a BANK LOAN usually do not finance the borrower with the accompanying costs to own the asset such as (installation, training, software, etc.).
- FINANCIAL LEASING as said is 100% financing and covers all accompanying costs.
- TAX WRITE OFF:
- In a BANK LOAN, as the investor is the owner of the asset bought by loan money, so depreciation and loan interest are the only tax advantages.
- In a FINANCIAL LEASE, the lease payments could be a form of accelerated depreciation depending upon the structure and they are 100% deductible.
⇨ Any remarks? Did I miss anything?
Eisfeldt A.L., Rampini A.A. (2006), "Leasing, Ability to Repossess, and Debt Capacity", SSRN Electronic Journal 22(461), p. 46.
Severin E., Filareto-Deghaye M., (2007), "Determinants of the Choice Leasing vs Bank Loan", Revista Investigación Operacional, vol. 28, No.2, pp. 120 –130.
"Firms now lease everything but time", Industrial Capital Group.
Financial Leasing and Bank Loan Comparison
Dear Mohammad, thanks for your excellent explanation of the difference between these 2 (bank loans versus financial leasing)....