Difference Between Loan vs Lease
Loan
A loan can be defined as giving money by one party to another party on the agreement that money would be paid back by the latter to the former by the loan agreement. Interest, tenure, and other terms would be defined in the loan agreement in advance.
Parties involved in the loan transaction are
- Lender – the one who gives money
- Borrower – the one who takes money
A borrower is supposed to pay back to the lender the principal amount along with interest over the tenure of the loan based on a loan agreement. There are different types of loans, based on the nature of the usage of funds it can be called from personal loans to business loans. Loans can also be categorized based on the collateral pledged by the borrower to the lender; it ranges from unsecured loans to term loans. In general, while taking a loan, the borrower has to collateralize some of his assets with the lender.
In a nutshell, irrespective of the nature or type of loan the borrower has to repay the lender principal along with interest over the term of the loan.
Lease
A lease is an agreement between two parties, where one party (the owner of the asset also called lessor) allows the other party (called lessee) to use his/her assets (assets can be anything ranges from real estate, machinery, equipment’s, etc.) For an agreed period in return of periodic payments. Generally, these periodic payments are fixed, and the quantum of periodic payment and the duration of the lease would be based on the lease agreement. In a lease, the collateral would be the equipment that is leased in most of the case.
A lease can be broadly categorized into a capital lease and an operating lease. In a capital lease, there is a provision to transfer the ownership of the leased asset to the lessee by the lessor at the end of the lease tenure. In the case of a capital lease, the lessee has to show the leased asset in the asset side and a loan equivalent to the value of the asset in the liability side of the balance sheet. Over the period of the lease, the lessee will depreciate the asset and pay back the loan to a lessor. In an operating lease, the ownership of the leased asset will remain with the lessor, and the lessee will return the asset once a contract is over. The lessee has to record the fixed payment in the profit& loss statement as a rental expense.
Head To Head Comparison Between Loan vs Lease (Infographics)
Below is the top 7 difference between Loan vs Lease
Key Differences Between Loan vs Lease
Both Loans vs Lease are popular choices in the market. let us discuss some of the major Difference Between Loan vs Lease:
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- A loan will give the right of ownership of the purchased assets to the borrower whereas in the lease it would be only the rights to use the leased equipment.
- Looking out for a borrower to finance the equipment that you need to purchase would be much more time consuming than leasing the same assets from a lessor.
- Owning equipment through the loan will allow the borrower to depreciate it in their books of accounts and thus can avail the tax benefit, whereas, in the case of a lease, a lessor is not allowed to depreciate the assets since there is no recording of assets in lessee’s books.
- If after a period of time, the subject equipment would of no more in interest for the business, the lease method would be much more flexible than the loan method.
- Off-balance sheet accounting provision for lease would give a better performance ratio of the business than what could have been the case with purchasing the assets using a loan (assuming all other things constant)
- There is a down payment in case of the loan whereas generally no down payment in case of a lease.
Loan vs Lease Comparison Table
Below is the 7 topmost comparison between Loan vs Lease:
|
Loan |
Lease |
| Financed purchase of equipment will give the borrower the ownership of such an asset. | In a lease, the lessee has the right to use the equipment and doesn’t have the ownership rights. |
| For loans, a general interest rate is variable based on an index. If the index changes the rate will also change | In a lease, most of the time, the periodic payment would be fixed. |
| In case of a loan, a borrower has to bring collaterals to cover the loan amount, at times it may be difficult for the borrower or business to arrange required collaterals. | For a lease, in most cases, the equipment leased acts as the collateral. Lessee need not have to bring any collaterals. |
| Many of the banks/lenders hesitate to lend money to institution/ individual whose nature of business/ equipment which they find difficult to understand. | Since the lessor is in the business of leasing out the equipment, it won’t be difficult for a business/ individual to get equipment on lease. |
| In the case of the loan, the borrower has to bring some amount of money in the form of a down payment. | Generally, in the lease, the lessee need not bring any down payment unless there are some special provisions in the contract. |
| A loan has to record as a liability in the balance sheet of the firm/ business. | A lease (operating lease) is an off-balance sheet item. The lessee can derive benefits from leased assets without recording the leased assets on the balance sheet. They have to record the lease payments as an expense. |
| Generally, assets purchased using a loan will be under the ownership of the borrower of such a loan. | Under a lease, ownership would be retained by the lessor and the lessee to return the assets unless there are special provisions to transfer the ownership to the lessee at the end of the contract. |
Conclusion
As mentioned above both loans vs leases have their own advantage as well as disadvantage. A decision of loan or lease should be made after making a holistic analysis of the business situation and the purpose of the equipment which is to be bought or leased. If the business doesn’t have enough funds to make the down payment or doesn’t have enough collateral to cover the loan, and has to use the asset, then the lease would work best. If a business wants to own the assets for the long term and has enough funds to bring as a down payment and can go through the documentation of finance, then the loan would be a better option. Also, it is important to understand the various implication of loan vs lease on books of accounts of a business so that the reader can correctly gauge the performance of the business.
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