Is a lease a good idea? It depends on what you are leasing. This post identifies the majority of the different lease options available and the pros and cons of each.
Whether you need merchandise, goods, larger equipment, or commercial space, the costs are often more than you can pay for in cash. With this in mind, it makes sense to ask whether or not you need the item for the long haul or whether a temporary exchange (like a lease) is more appropriate.
This is where a lease comes into play. However, there are so many different types of leases it can be difficult to understand all of your options. It does not help that aside from all the different kinds of things you can lease, there are also often multiple ways you can lease any given item.
That is why we decided to break down leasing to identify what types of leases are available and when they are a good or bad idea. We also cover some of the less common aspects of some leases to ensure you do not get blindsided and end up with buyer’s remorse.
What Is A Lease?
At its core, a lease is a contract between two parties, the lessee and the lessor, where the lessor (generally) retains the rights of ownership over whatever asset is used by the leasing customer. However, the various types of assets that can be leased and the numerous terms for how the lease works make this question a bit trickier to nail down.
How Does A Lease Work?
For the most part, a lease will provide the lessor the right to use the leased asset for particular purposes, depending on the type of lease. If the lessee is an entrepreneur, the lease likely allows the asset to be used for commercial purposes, carrying additional risks or even a different payment schedule.
On the other hand, a residential or consumer lease tends to restrict the lessee more in using the asset and often covers more of the overhead costs. On top of that, a residential or consumer lease tends to include fewer payment models, though the contracts generally empower the lessor far more during extenuating circumstances.
What Are The Common Terms Of A Lease?
All leases start with a couple of standard terms, with the first being the amount of the payment a lessee must pay and the payment period. Another term that accompanies all lease agreements is the amount of time the lessee maintains the rights of usage for the asset from the lessor and a minimum leasing term.
Depending on the type of asset being leased, there are often terms that define who in the lease assumes the asset’s risk in terms of maintenance and other financial burdens (think vehicle oil changes and tire rotations).
Finally, the agreement will generally state what happens once the lease agreement concludes, though the specific type of lease can complicate this a bit.
Keep in mind, the prerequisites and other moral clauses may be terms included in the lease, but they are not always standard, as we will later see.
Different Types of Leases
The sheer number of different lease types is one thing, but when you consider how many various leases exist within a given group, it can make your head spin. We went ahead and put together a list of the different primary types of leases and the different variations of each type.
We also made it a point to examine some of the different terms and other considerations you might need to make when signing a lease agreement. It should be noted, from here on out, we will be considering leases from two primary perspectives: the consumer and the commercial lessee.
The consumer lessee is your average person who leases an asset for their personal use and does not intend to use it for any extenuating reason. On the other hand, a commercial lessee leases the asset explicitly for use to run a business that will modify how much cost and risk they take on for the rights to use the asset.
Of all the leases taken out, these tend to be the ones that people overlook – but are just as prevalent as any other lease. A merchandising lease is where you acquire the right to use an asset that is also a general consumer good, more often than not, some type of household appliance or furniture (i.e., Rent-To-Own or WhyNotLeaseIt.com).
It’s worth noting that although merchandise leases focus on consumer goods, they can actually cover both consumer and commercial lessees. However, a commercial lessee is likely going to pay a significantly higher rate than a consumer lessee, given that the leased item is intended to be used more often.
Keep in mind that most goods in this category need to fall under a “qualifying merchandise” banner with a price floor. This type of lease tends to operate through a leasing program like Why Not Lease It, Sears, TEMPOE LLC, or the LEASE IT program.
This is your standard lease where the lessee signs the agreement for a specified amount of time (minimum term) and can either re-lease the asset or trade it in. Whether a commercial or consumer lessee, be especially careful of the terms for this kind of lease to ensure you do not incur additional costs once the lease concludes.
If you have seen the advertisement for “rent or lease to own,” this is the type of lease that statement refers to. While you might associate the option lease more with vehicles or property, it is actually more common for merchandising assets.
Of all the different types of leases available, vehicle leases might make the most sense given the various benefits and drawbacks of the cost of ownership. One of the main reasons is the value of a vehicle depreciates with time, and the most significant drop comes at the front end. This usually prevents recouping its cash price after the initial purchase.
On top of that, passing off more of the risk to the lessor is extremely helpful for monthly expenses where a sudden vehicle problem can cause quite a cash crunch. This is another type of lease that is often associated with consumers but has a thriving commercial market.
*It is worth noting that vehicles and merchandise are occasionally available to lease with a credit card.
This is your standard vehicle lease where you make an ongoing lease payment each month for the length of the contract and return the asset once the contract concludes. There is no flexibility with the mileage or depreciation costs, which ultimately creates lower periodic payments but more risk.
While the closed lease might be “standard,” the open vehicle lease is more common as it provides you a bit of wiggle room. This type of vehicle lease allows flexibility with the mileage and depreciation, but it also comes with a higher monthly payment.
While not exclusive to vehicles, this is most commonly an auto lease where some of the cost is assumed by either the manufacturer or the lessor. This type of lease has some of the lowest payments and is often used more as a marketing tactic than a standard type of vehicle lease.
Single Payment Lease
As the name implies, a single payment lease requires you to pay a lump sum upfront instead of periodically. While this reduces some of the benefits of a periodic payment plan affords, this kind of vehicle lease also has a lower overall cost for the contract terms.
While most vehicle leases apply to new cars, you can lease a used car as well – usually at a significantly lower rate. So long as you do not require the latest model, this is a great way to save some money on an otherwise good vehicle, but the number of vendors may be limited.
This type of lease does not function that dissimilarly to standard vehicle leases except that the minimum lease term is either longer or shorter than usual. A short-term vehicle lease will usually be less than 24 months, while a long-term lease is liable to extend for five years or longer.
Like with merchandising purchase option leases, vehicle leases often provide you the ability to purchase the vehicle following the conclusion of the contract. However, this is one of the worst types of option leases you can take out, as vehicular depreciation is some of the worst. Generally, you only accept this kind of vehicle lease when you want to own a vehicle but do not qualify for financing due to your credit score.
A capital lease is another type of commercial vehicle lease, but it is likely not the kind you want. A capital vehicle lease classifies the asset as both an owned asset and a financial liability, but you do not own the asset. The main issue with a capital vehicle lease is that you cannot deduct the lease’s cost from your applicable taxes.
An operating lease is similar to a closed-end vehicle lease you would get as a consumer but applied to a commercial lessee. Much like with a closed-end lease, you have fixed mileage and lower lease payments, but the fact it is used for a commercial purpose often makes it easier to calculate what kind of mileage you require.
This is the last of the commercial subsection of vehicle leases and refers to leasing multiple vehicles at once. If your business requires numerous vehicles, it makes sense to lease them all from the same dealer, as this will bring down the cost of each vehicle’s lease amounts.
This is strictly a consumer lease and is otherwise known as renting, whether you rent a house, apartment, or any other kind of “residence.” Keep in mind, the following type of lease (Commercial Lease) can include a building and property but will almost certainly not allow you to live in it unless it consists of an add-on specifically for that purpose.
This is one of the few types of leases that does not carry a lower periodic payment, though when you consider the down payment on a home, it can still be cheaper to lease. It is also worth noting that this asset appreciates more than most, making the drawback of not owning the asset hit a bit harder than the types of leases covered prior.
Periodic or Month to Month Lease
This kind of residential lease is best for people who only expect to be in a given area for a short amount of time or need a cushion while looking for a better place. This type of lease is almost always the most expensive and carries the greatest risk of a price hike from contract to contract.
Fixed Term Lease
This is the most common type of residential lease that sees the lessee maintaining rights for around six months to a year, though it can extend longer. The rates of a fixed terms lease are lower, and the stability allows you to better plan your budget, though it tethers you to one spot for the length of the lease.
One Way Lease
This is a particularly onerous type of monthly lease payment schedule that penalizes the lessee for early termination. It is called a one-way lease because it does not really benefit the lessee, though this may be the only kind of residential lease someone with an extremely spotty credit history can get.
A proprietary lease is unusual. It is similar to an option lease, except you do not end up owning the property per se following the contract’s completion. Instead, you own a share of the property’s holding company, but it also means that you are subject to the company’s board decisions.
Sublease of Sublet
This is another unusual type of lease transaction in that you are technically both the lessor and the lessee. While you are the lessee for the original lease, you then lease out the property to someone else and become their lessor – though this type of lease almost always requires special permission from the original lessor.
Tenancy at Will
This is arguably one of the more tenuous kinds of lease and is only legally a lease in name, though not in spirit. Unlike the other types of lease, tenancy at will is made without a contractual agreement and can be terminated by either party at any time for any reason.
Tenancy at Sufferance
If tenancy at will is not the most tenuous, then tenancy at sufferance is. In this contract, the lessor is likely actively trying to get you out of the property. This is another situation where there is no active lease agreement. However, unlike tenancy at will, tenancy at sufferance once had a lease agreement that is still being honored even following completion of the original lease contract.
As the name implies, these leases are designed for commercial purposes, though some of the products included in the leases discussed prior might also fall into this category. However, the assets considered in this section focus more on commercial property and non-consumer equipment.
For the equipment, this can technically include vehicles, though we will only focus on heavy vehicles for the commercial lease section. However, the more common types of assets leased for commercial purposes are buildings, property, and heavy equipment used for manufacturing or other durable goods preparation.
This type of lease will often include a leasing partner that acts as a lessor for multiple assets to the lessee. Keep in mind, many commercial vehicle leases may restrict your ability to employ an independent service provider.
In terms of hands-off ease, this is one of the better types of commercial leases available because the lessor assumes all risk. However, be sure to know what the “load factor” is as lessors often include one to help offset the operating costs they pay on the asset.
Modified Gross Lease
This type of commercial lease is similar to the gross lease, except instead of paying a load factor, you include some set amount into the cost of the lease to offset the operations. Technically, some of the proceeding types of commercial leases fit into this category, but there are so many different potential configurations, it deserves its own mention.
Triple Net Lease
Depending on your needs, this is either the best or the worst kind of commercial lease available as it requires you to pay rent, insurance, maintenance, and taxes on the asset. However, if your operating expenses are inherently low, the lower rent costs often make this a good option.
Double Net Lease
Like the type of commercial lease above, the double net lease requires you to assume some operational risk with insurance and taxes. This type of commercial lease is still lower in cost on rent and is a solid option for those assets that are likely to have higher maintenance costs.
Single Net Lease
As with the other types of net leases, the single net lease has a lower rent but is closer to the middle range as your only additional risk is taxes. If your business’ asset requires a fair bit of maintenance and may be more inherently dangerous, this is an excellent way to save a bit of cost.
Technically, the absolute lease is a type of net lease but leverages even more risk onto you. Though this type of lease has one of the lowest rental rates, be extremely careful to scrutinize the asset first as you will be on the hook for things that break.
This type of commercial lease is almost exclusively reserved for retail business as other business types may not sell directly. While you do not have to worry about the operation costs and risks, you will be expected to pay a percentage of your sales to the lessor making it one of the trickier leasing transactions to figure out in terms of value.
Lease Option / Finance Lease / Capital Lease
As with the other instances of this type, your payments ultimately build towards purchasing the asset once you fulfill the lease’s contract. Depending on the type of business and lease, this can be a decent option – specifically, if your company does reasonably well and the asset is future-proof.
Sale and Lease Back
This is a tricky type of commercial lease as it is generally used to generate some quick capital and requires the lessee to own the asset initially. The asset’s sale is made with the explicit requirement that the asset is leased back to the selling party.
Benefits Of A Lease
As we evaluate the pros and cons of a lease, this section outlines the benefits of a lease.
For the most part, lease agreements tend to be cheaper than most other forms of payment for the use of assets – though you are only paying for the use of the asset. You may often hear about how much cheaper it is to buy your home than it is to lease, but that only covers the monthly mortgage and does not include the down payment.
This benefit is only magnified for commercial leases as you may not intend to own expensive pieces of equipment for any foreseeable future. Given that small businesses often need to manage their capital efficiently, a lease’s lower initial payment can help save for more important costs.
This might be one of the best benefits regardless of whether you lease the asset for commercial purposes or personal use. Since financing can only be done through a limited number of outlets, the financiers have all of the leverage. They can dictate the terms however they see fit – and generally do so in their best interest.
Since lessors have a bit more competition and their inherent drawbacks (which we get to later), they have to be more accommodating to potential lessees. This leads to a broader array of available lease agreements that allow you to find the contract that best suits your short term or long term needs.
This flexibility also often extends to payments, with some leases even offering a weekly or biweekly lease payment schedule.
This benefit can be a bit tricky depending on your contract terms and favors consumer lessees more than commercial ones. Granted, there are plenty of commercial lease agreements that still reduce the amount of risk you incur on the asset, but they generally pale compared to the consumers’ lease deals.
You are almost always covered on general maintenance, taxes, and other risks for a consumer lessee, assuming you use the asset as defined in the contract agreement. On the other hand, a commercial lessee will pay a bit more towards risk on property assets than a consumer lessee tends to.
Compared to financing, leasing tends to be significantly easier and more streamlined, though this hinges on a couple of different factors. For consumer lessees, if you have a good background and decent credit, you should have no difficulty getting a lease for most personal-use assets.
For commercial lessees, the ease of acquiring an asset lease will depend on how long you have been in business. For both commercial and consumer lessees, lease contracts are generally easier to get and simpler to understand – though you should still have a financial advisor or an attorney look over the agreement before signing.
Granted, this quality benefits commercial lessees more than consumer ones, though particular circumstances might see it benefit both. Commercial lessees lease assets so they do not have to pay the higher upfront costs on expensive pieces of equipment necessary to run their business.
Aside from the fact that leased assets tend to carry lower costs than purchased assets, you also do not have to worry about large down payments. This means that the money you would otherwise use for a down payment can be used for any number of business expenses or to simply provide a better balance sheet to potential investors.
This benefit is a bit narrow in scope in that it does not apply to consumer lessees who cannot make use of too many tax deductions for their leased assets. However, commercial lessees can make great use of numerous tax deductions for any asset they lease for a commercial purpose.
Aside from the fact that the lease can often be written off as a business expense, it also allows you to pay for the lease with pre-tax dollars instead of post-tax dollars. However, leasing assets for commercial purposes does not allow you to claim depreciation deductions and puts you at the mercy of potential changing tax codes.
While the primary type of lessee this benefits is commercial, it can also benefit a consumer lessee depending on your tastes. For the commercial lessee, the benefit is obvious in that you do not have to worry about your equipment becoming obsolete and can always lease newer equipment with the next contract.
For consumer lessees, this is definitely a bit more of a vanity benefit, but there are plenty of legitimate reasons to consider it as well. While driving around in a new car every couple of years is nice, upgrading appliances to the newest models with additional bells and whistles can provide functional value.
While this benefit applies more to people with consumer leases, it can still benefit commercial lessees as well – especially those who are just starting their business. As a contracted payment agreement, every payment you make ultimately demonstrates you are a reliable person who can be trusted to make payments in the future.
This benefit is especially true once you successfully complete the lease agreement as it highlights you can be trusted to make periodic payments, and you can do so for an extended time. While the initial credit benefits of a lease favor consumer lessees, the long term credit benefits favor commercial lessees.
Drawbacks Of A Lease
On the opposite side of the spectrum are the cons and drawbacks of a lease.
At the end of the day (or lease agreement), all of the money you spent paying for the use of the asset does not change who owns the asset: the lessor. This is less of an issue for commercial leases as the lease likely allowed for alternative uses for capital and helped insulate you from some of the risks.
For consumer leases, this aspect tends to hit a bit closer to home since you will ostensibly never stop paying on the asset depending on the type of lease. However, those with consumer leases should consider what they save on maintenance and risk, especially if they have a steady income stream.
While owning the asset confers the privilege of outright control, that is often not the biggest drawback to not owning the asset. Instead, the most significant loss is the absence of equity that both consumer and commercial lessees lose out on and the potential financial power afforded for other purposes.
For consumer and commercial lessees alike, equity builds your personal portfolio of assets and allows you to further leverage those assets in acquiring other assets. Since the leased asset is owned by someone else, you cannot use it for financing or valuation purposes when applying for loans or investment.
Since the asset is not your property, you are likely extremely limited in how you can alter it from its starting condition – if at all. Granted, this depends heavily on the type of asset in question, with buildings and property offering a bit more leeway, assuming you cover the costs both to alter and if the lessor wants it returned to the prior condition when the lease ends.
In fact, some lessors may even include special provisions that allow you to make alterations as part of the lease’s payment if the lessor would otherwise make those changes anyway. However, there are few instances when you will be allowed to alter equipment or other consumer goods, regardless of the type of lease.
Getting out of a lease can be extremely difficult, if not impossible, depending on how the lease is structured, regardless of whether it is for consumer or commercial purposes. On the plus side, most consumer leases have some form of an opt-out clause, but it will likely cost a pretty penny in a penalty fee to enact it.
While commercial leases tend to favor the lessee more than consumer leases, they also tend to come with far heavier penalties for defaulting and have fewer options to cancel the lease. Either way, defaulting or canceling a lease will often stain your credit, which may influence other financial transactions in the future.
While some of these considerations weigh heavier depending on whether you lease for commercial or consumer purposes, accessibility can be difficult for both situations. Granted, leasing often tends to be more accessible for consumer purposes, in general, but your history may come into play.
For example, if you already have a defaulted lease on your consumer record, that may make it difficult to get a lessor to sign a contract with you in the future. For commercial purposes, one of the biggest hurdles to clear comes from how long you have been in operation as newer businesses have more difficulty finding lessors before demonstrating success within their market.
If you are an entrepreneur leasing equipment or property to run your business, there is a decent chance the lease contract will still require you to pay some of the interest on the asset if it is not yet paid off. That said, it can still be in your best interest to lease the equipment even with this caveat.
First off, your total payments are still likely to be less than if you purchased the equipment yourself, even including the interest payments. On top of that, the amount you pay towards the interest of the asset is still likely to be less than the amount of interest you would pay for financing the equipment, meaning that you still pay less on both fronts.
Should you lease an asset and then later decide you want to purchase it, you better make sure the terms of the lease include that option and also present a favorable deal. The main reason for this is that most leases that provide the opportunity to buy the asset will still require anywhere from 10% to 20% more of the original price than you paid during the lease.
This means that you may very well have to pay upwards of 90% on the asset during the lease and then still owe another 20% to 30% of the asset’s original price. Keep in mind, this additional cost does not include the amount you paid on the interest if you are a commercial lessee.
While leases come with more benefits than drawbacks – assuming ownership is not your ultimate goal – they still have plenty of hurdles you need to cross before you are given one. Generally, the biggest concern of a lessor is income requirements or the lessee’s ability to make their payments, assuming they do not pay upfront.
Depending on the payment amount and the length of the contract, the lessor is also liable to check the credit of the potential lessee or their length of operation. On top of that, both consumer and commercial leases are likely to require some form of insurance to help prevent the lessor from incurring any unnecessary risk.
While it might seem obvious for vehicle rentals, you will also need to provide some form of valid photo ID to verify your identity and the lessor’s records should they be required in the future. Finally, different types of assets may limit the number or specify particular people who can use, operate, or occupy the leased asset.
Is A Lease Right For You?
If you are a small business owner, there are likely numerous instances when a lease is a good option, especially if you do not have a significant amount of capital upfront. Even if you have plenty of capital, it is not always the best idea to outright own and assume all risk for expensive pieces of equipment vital to your business.
For the average consumer, a lease is a good idea if you have a steady income that is unlikely to change anytime soon, and you do not foresee keeping the asset acquired. Leasing vehicles often fall into this category as the lease tends to include most standard maintenance. Still, any consumer lease is a reasonable idea for someone who needs the asset but cannot afford the lump sum or financing payments.
However, if you struggle with debt, purchasing an older used vehicle makes more sense than renting a car in the form of a lease.
As we can see, lease signing is a frustratingly complex subject that only gets more complex when you consider how many different types of assets are leased, the different types of leases for each kind of asset, and the various additional terms that may or may not apply.
It can be challenging to determine whether a lease is the right option for you, but why you need the asset should be a big clue – especially if you are an entrepreneur. For a consumer, your ability to pay, combined with your desire to ultimately own the asset once your lease concludes will likely drive this decision more.
Keep in mind, there are plenty of benefits to leasing if you make sure that the contract covers everything you need, whether you are a small business owner or the average consumer. That said, you should get a financial expert or lawyer to look over any potential lease agreement and ask as many questions as come to you (and maybe a few that friends and associates can think of) to make sure the lease agreement works for your needs.