What Is Asset Finance and How Does It Work?

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manny

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Published on February 19, 2021

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As someone who wants to start a new business, you must have seen the term ‘asset’ dozens of times. ‘Use our latest asset finance software! Our asset finance calculator will let you know how much you can spend!’ But what exactly is asset finance? How does it work and can it help you grow your business?

In this article, we will cover the basics of asset financing. Hopefully, it will help you learn how useful this type of financing can be for upcoming entrepreneurs. 

So, What Is Asset Finance?

Before we answer the question above, let’s first define the key component here. What is an asset in finance and investment? Well, it’s anything that has some sort of economic value to the owner. This asset can be used by the owner to gain a benefit in the future. Basically, an asset can be anything from company inventory to various investments. And since the company requires these elements to grow, it needs to manage them properly.

The question then becomes ‘what is asset financing?’ Broadly speaking, is a type of loan where the company borrows money to finance the purchase of a new property.

Here’s an example of asset financing in action. Let’s say that you run a moving company and that you have an opportunity to grow. However, you’ll need an additional moving van — an asset that can cost up to $43.000. But instead of buying it for a lump sum, you can use an asset finance loan. Usually, you’ll be able to borrow up to 100% of the van’s price. Once you do, you can pay it off over time, and then it becomes your property.

Different Types of Asset Financing

There are five types of asset finance. You can pick one depending on what you plan to buy, how long you plan to keep it, and how you wish to pay the asset off.

1. Hire Purchase

Hire purchase is a simple process. The lender buys an asset on the behalf of the borrower while the borrower pays it off over time. Until they do, the lender completely owns the asset. Once the final payment is done, the borrower might buy the asset off at a nominal rate. 

2. Equipment Lease

With an equipment lease, the borrower will use an asset (in this case, equipment) for a certain period of time. Once the time is up, they can choose to do one of the following:

  • Return the equipment to the loaner
  • Upgrade to the latest equipment
  • Extend the equipment lease
  • Buy the equipment outright 

3. Finance Lease

A finance lease is a variant of the equipment lease. When the borrower makes a loan with this lease, they hold full responsibility for maintaining the asset. As long as the lease is active, the borrower has to take care of the asset and act as its owner. By the end of the lease, the borrower can buy the asset off. 

4. Operating Lease

While also a variant of the equipment lease, an operating lease differs from it in a few ways. Namely, the borrower will only use the asset for a short time. Moreover, the payments will not be reflected in the actual value of the asset. Rather, they will vary depending on how long the asset was used. 

5. Asset Refinance

Asset refinance is essentially loaning money based on the assets you already own. For instance, if you have vehicles, buildings, or equipment, you can use their value to loan additional funds. The loaner will claim ownership over the asset until you repay them, but you still get to use the asset in the meantime. Interestingly, you can refinance assets that you don’t even fully own and simply loan the percentage of equity that you’ve already paid off. 

Why Use Asset Finance? The Pros and Cons of the Practice

There are lots of benefits to asset financing. Firstly, they are easier to acquire than most bank loans. Next, your agreements will almost always have fixed interest rates. Finally, even if you don’t pay off everything, you will have minimal losses, i.e., you will only lose the asset. 

However, this practice isn’t perfect. Losing an important asset might cripple your company in the long run. In addition, the value of assets can fluctuate, so you might not get enough money. Most importantly, asset finance isn’t the best solution if you need long-term funding.

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