Capital Lease
What does it mean
There are two primary types of leases: Operating Lease and Capital Lease. A Capital Lease is an agreement between two parties where one party agrees to pay for the opportunity to use an asset for a set period of time, and at the conclusion of the contract, the company paying the lease payment has the option to purchase the asset being leased at a predetermined price. Due to this potential change in ownership, Capital Leases are listed on the borrower’s financial statements similar to how a loan is listed.
Why does it matter
Knowing the difference between the types of leases a borrower has impacts a bank in the following ways:
- Capital leases involve a change in ownership in the asset, and a borrower can build equity in capital leases overtime
- Capital lease payments are not an expense item on the income statement; so their payment needs to be factored into any Repayment Ratio like any other loan
- Both the asset being lease and the obligation of payments is listed on the borrower’s balance sheet, just like a loan
Other Relevant Terms
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