Asset finance is a flexible financing option for borrowers. It can be used for assets owned by a business to pledge for a new loan or to purchase a new asset. Another option with asset financing is to obtain the use of assets.
Asset financing can take various forms depending upon the terms and the nature of the asset purchased.
Asset finance definition
This type of financing is when the borrower uses assets as collateral to borrow money. It offers quick and easier access to short-term financing. Borrowers can use assets already owned to pledge with the lender and obtain financing.
Since the lender is secured with the use of collateral, it is termed a secured financing type. The interest rate on these loans is usually lower than on unsecured loans as well.
Thus, asset financing can use tangible assets such as machinery, equipment, plant, and land as well as intangible assets such as accounts receivable.
How asset finance is used
Companies use asset financing in two ways. First, to secure new assets that cannot be purchased with cash payments outright. Second, to access financing by pledging already owned assets as collateral with the lenders.
In many cases, a company will use asset financing to obtain usage rights of an asset without purchasing it immediately. Depending on the contract type, the ownership of the asset may transfer to the borrower at the end of the contract term.
Traditionally, companies use creditworthiness to obtain new financing. However, pledging assets as collateral offers an alternative approach. Therefore, it lowers the credit risk of the borrower and makes financing terms easier. Lenders usually offer financing amounts up to a certain
Types of asset finance
Asset financing can be arranged in different ways. The financing terms and the type of asset would determine the characteristics of the loan agreement. Here are a few common types of asset finance:
In this type of asset finance arrangement, the lender purchases the asset required by the borrower. The lender then leases the asset to the borrower and defines the lease terms. However, the borrower does not need to pay upfront for the purchase of the asset.
The borrower makes regular payments in the form of installments over the lease term. The lender retains the ownership of the asset until the full payment of the asset is received. At the term expiry, the borrower has the option of purchasing the asset from the lender.
In a financial lease, the ownership stakes and obligations of an asset are transferred to the borrower. However, the borrower does not own the asset legally. The borrower makes regular lease payments to the lender.
This type of asset financing is usually considered when the borrower requires using heavy equipment, expensive assets, and sophisticated machinery. The borrower can share a portion in the sale of the asset after the lease term expires.
An operating lease is also borrowing an asset from a lender. The contract entitles the borrower to use the asset for the term of the lease. However, the ownership of the asset remains with the lender.
An operating lease is an ideal option for borrowers that seek temporary usage of assets. The option is cheaper than buying an asset with full payment. Thus, the lenders charge for the rented or lease period of the contract only.
An equipment lease is a similar arrangement to an operating lease. It is usually used for specialized equipment and machinery. However, when the borrower does not want to purchase a costly asset, an equipment lease offers an alternative option. Thus, the borrower makes smaller regular payments over the leased period.
At the end of the equipment lease, the borrower can renew the lease or purchase the asset at the prevailing market price.
Asset refinancing can be arranged in two different ways. First, the borrower uses already owned assets as collateral to obtain financing from the lender. It works as a secured loan and reduces the credit risk. The borrowers save interest costs and obtain easier access to financing.
Second, the lender purchases an asset for the borrower. The asset is then leased to the borrower for a specified term. The borrower makes small regular payments as lease installments. At the end of the lease term, the borrower will take the asset ownership.
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