Asset finance allows businesses to acquire bigger purchases, such as vehicles, machinery, or equipment, by paying for them over time rather than upfront, using the asset itself to guarantee the loan.
To understand whether asset finance would be the best payment option for you, it’s crucial b
oth to get an understanding of interest rates (as these will directly impact how much your loan will cost you) and to understand all of the implications of choosing asset finance for your purchase.
What is Asset Finance?
Unlike traditional loans, asset finance is a deal specifically designed to help you to purchase one particular asset. Instead of being based on your credit-worthy status, asset finance uses the asset you’ve purchased as collateral, meaning that the lender can seize the asset if you default on payments. They are often easier to secure than a traditional loan, as the financier isn’t gambling on your financial stability. Repayments are usually fixed installments over a set period, which makes financial planning easier. Another advantage is that they can be tax-deductible for businesses.
Types of Asset Finance
There are several types of asset finance. Three common ones are:
Hire Purchase:
Hire Purchase Asset Finance, or HP, is where you “hire” the asset. Making regular payments, you eventually own it outright once you’ve fulfilled your side of the agreement and paid an additional option-to-purchase fee.
Leasing (finance & operating):
A lease allows your business to pay a regular rental fee for a specific period, but the ownership stays with the leasing company. It is similar to a loan, in that you will take ownership of the asset once you’ve made the repayments. Operating leasing, meanwhile, entails the asset finance firm keeping the asset, loaning it to you and handling maintenance. With asset finance leasing, the asset finance firm actually purchases the asset on your business’ behalf, and then leases it to you. Your business will take ownership over the asset once you’ve made your repayments.
To fully understand the differences between hire purchase and leasing, check out our blog here.
Contract hire
This type of asset finance is regularly used for car leasing. It allows businesses to pay fixed monthly rentals to lease a car for a set period, with set mileage limits, but the business doesn’t shoulder any further costs or take ownership of the asset.
How cost structures and interest rates affect the affordability of asset finance
Interest rates always have a direct impact on the cost of your asset finance agreement, because they control the amount of money paid to the lender on top of the loan itself.
Market conditions can vary drastically, and this can impact your asset finance deal. Other factors that impact your rate will be the type of asset you’re going for, your business trustworthiness, and the lender’s risk assessment.
Understanding the market and current and forecast interest rates will help you to ascertain which asset finance option is the most cost-effective for your asset.
The Fundamentals of Interest Rates in Asset Finance
What are interest rates?
Interest rates are a percentage added to your purchase, which represents the cost of borrowing money.
Fixed interest rates will remain constant for the duration of your loan, whereas variable interest rates will fluctuate with the market. A fixed interest rate gives you security in the knowledge of your fixed repayment amount, but if the market goes down, it will be cheaper to take the risk on a variable rate (which could also, of course, inflate, costing your business more).
When considered within asset finance, fixed rates are often higher than variable rates at the beginning of your asset finance agreement. There are also sometimes early repayment fees if you wish to pay off your loan early.
Variable rates, meanwhile, fluctuate on market conditions, often linked to the Bank of England base rate. They usually offer lower initial payments, so you save money in the short term, and often offer more flexible terms (fewer penalties for early repayment). However, they provoke budget uncertainty, as repayment costs will fluctuate, and may cost more if interest rates rise.
Dissecting the Cost Structures: Beyond the Interest
Interest payments:
With asset finance, interest payments form the bulk of the cost beyond the asset repayment. They aren’t the only cost, though, as various fees (including origination fees, documentation fees and valuation fees), as well as early repayment fees, may also contribute to your overall repayment.
Fees & Charges:
Your lender should be completely transparent about any and all charges you can expect during your asset finance agreement. Upfront charges to expect include things like processing fees, and then there are recurring fees such as administration fees alongside your interest payments, and any early termination fee. Depending on the asset, you might also face stamp duty, valuation fees, and insurance costs.
A Balloon Payment, or Purchase Fee, is the final payment you should expect in order to purchase your asset outright, once your lease period is up.
Residual Value (RV) is your asset’s estimated value at the end of the asset finance agreement. This is what is used to work out your Purchase Fee or Balloon Payment.
How Interest Rates and Costs are Determined
Credit spreads and lenders’ base rates will determine the cost of financing assets.
A Lenders’ Base Rate is the basis from which interest rates in asset finance agreements are set, and is often based on the Bank of England’s base rate.
Credit spreads are additional percentage points that will be added to the base rate, which are determined by the specific borrower or the specific asset. A strong credit history may bring you a lower credit spread, for example, and assets with higher resale value (or a lower risk of depreciation) may also bring you a lower credit spread. Market conditions also impact your credit spread.
The length of your repayment term will also affect the cost. Asset depreciation over time will, of course, impact the asset’s value, too.
When considering asset finance as a way to purchase the equipment you need for your business, it’s important to understand the impact that the interest rates and the inherent cost structures of the deal you choose will impact your agreement.
Asset finance can be a brilliant way to acquire what you need, now, but you need to compare offers from distinct companies, look into the type of asset finance deal that will suit you best, and do your due diligence when it comes to any associated fees and additional costs.
Seek out tools and expertise to ensure you are making future-friendly, cost-friendly financial decisions. Here at Kane Financial Services we are experts in asset finance. If you need some expert advice on asset finance, get in touch with us today.