In a prior post, I covered the difference between apples and oranges and how oranges taste so much better. Never mind that was on another blog, I did however cover the differences between a lease and a loan, and as promised, I wanted to clarify some of the common residual types.
In review: A Lease by definition must have some type of residual at the end of the term; imagine a residual to be a portion of the original cost that is left unfinanced. Common residual options include (but are not limited to) $1.00, 10%, and Fair Market Value. Each of the options can be appended with the words Purchase Agreement or Purchase Option. (Remember this for next time).
$1.00 Purchase: Currently, this is the most common type of end-of-lease residual and is often referred to as a “lease purchase” structure. In this agreement, the customer is financing all of the equipment cost and owns the collateral at the end of term by paying $1 to the Lessor. (Now obviously the $1.00 residual is somewhat of a technicality.) This structure yields the highest monthly payments, but also a next to nothing residual at the end of the lease term makes it a great choice if you want to own the equipment.
10% Residual: In the case of a 10% Purchase Option lease structure, the customer is essentially financing 90% of the equipment cost leaving the remaining 10% as a residual at the end of the term, hence the name. This structure has a lower monthly payment than a $1 purchase agreement for the obvious reason that 10% of the cost is deferred to the end, but also has a 10% residual (kind of like an optional balloon payment) left at the end of the term, which in most cases can be financed again, or (of course) paid in full in cash.
FMV Residual: Though not difficult to understand, this structure typically is difficult to explain so I will reserve this for a later date and time.
Stay tuned while I formulate my thoughts on explaining the difference of a purchase option versus purchase agreement and the infamous FMV.
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