7 Mar 2024

Operating Lease vs Finance Lease

Looking to finance your business’s vehicles?

Operating Leases and Finance Leases are two popular options that offer benefits to your business, from improving your cash flow to reducing vehicle-related admin.

In this guide, we explain each type of lease and the key differences between them.

What is an Operating Lease?

Operating Leases are leases that are taken out by businesses (the lessees) from finance companies (the lessors) for vehicles, including cars, utes, vans, SUVs, and electric vehicles for a specified term and kilometre limit.

With a Fully-Maintained Operating Lease, the running costs – including registration, servicing and tyres – are bundled into one monthly payment. The lessor will take into consideration how many kilometres you drive and how long you plan on leasing the vehicle when calculating the monthly cost.

At the end of the lease period, the car is returned to the lessor and ownership cannot generally be transferred to the lessee. This means that the lessor also takes on the residual value risk of the vehicle, such as changes in the car’s value and fluctuations in market conditions.

Fully-Maintained Operating Leases are a very popular method for businesses looking to finance their vehicle fleets – or even a single car. The key reasons for this are:

• they don’t require a large capital outlay in the form of an upfront deposit nor is a payment of a residual value (also known as “balloon” payment) required at the end of the lease;
• monthly payments are spread over the lease period, which make it easier for businesses to manage their cash flow;
• the lessor covers the cost of servicing and maintenance, which makes running the vehicle more cost-effective; and,
• Operating Leases are an admin-free way for businesses to manage tasks like rego renewal and insurance, as these are handled by the lessor.

What is a Finance Lease?

A Finance Lease is where the lessor buys a vehicle on behalf of a lessee. The vehicle is registered in the lessee’s name, but owned by the lessor. At the end of the lease contract, ownership of the vehicle is transferred to the lessee, who will be required to pay the residual value (also known as a “balloon payment”) of the vehicle.

In the case of a Finance Lease, the lessee is usually responsible for the running costs of the vehicle. Because ownership of the car is transferred to the lessee when the lease comes to an end, the lessee is also responsible for the residual value risk of the vehicle, which may be subject to variations in market conditions.

Like Operating Leases, Finance Leases are a good way for businesses to manage their cash flow, spreading out the costs of the vehicle over the lease term, typically 2 to 5 years, rather than making an upfront payment.

Operating Lease versus Finance Lease. The difference explained

There are four key differences between Operating Leases and Finance Leases. They are:

Ownership

With an Operating Lease, the lessor retains ownership of the car at the end of the lease term. In a Finance Lease, ownership is transferred to the lessee upon payment of a final lump sum.

Running costs

With an Operating Lease, running costs are included in the lease. In a Finance Lease, running costs aren’t included, which means the lessee will be responsible for making payments for these additional expenses.

Residual risk

With an Operating Lease, the lessor is responsible for the residual value risk, but in a Finance Lease, the lessee takes on this responsibility when ownership is transferred to them at the end of the lease. 

Extensions

Operating Leases can be extended at the end of the lease term; this usually isn’t the case for Finance Leases.

FAQs related to Finance and Operating Leases

How is depreciation handled in an Operating Lease vs a Finance Lease?

In an Operating Lease, the lessor is responsible for the residual value risk of the vehicle. In a Finance Lease, the lessee takes on this risk and will have to make a residual lease payment at the end of the lease term.

What happens at the end of the lease period in both lease types?

At the end of an Operating Lease, the lessee returns the car to the lessor, or may be able to extend the lease term. At the end of a Finance Lease, ownership of the vehicle is transferred to the lessee, who will be required to make a residual payment.

Making the best choice for your business

Operating and Finance Leases both offer benefits to businesses when it comes to managing their cash flow, but come with differing levels of responsibility for the vehicle.

If you’ve got questions about your leasing options and need help deciding what’s right for your business, or would like to get a quote on new business vehicles, get in touch with the FleetPartners team on 1300 666 001.