Terms and Definitions

Common Terms and Clauses

Before you negotiate a personal or commercial auto lease, you should understand the common lease terms and clauses used in a lease agreement before and during discussions with the lessor. The information below will help you familiarize yourself with some of the common lease terms used in most agreements.

Lease

A contract between a Lessor and a Lessee for the hire of a specific asset. The ownership or asset is retained by the Lessor, but the right to use the asset is given to the Lessee for an agreed period of time in return for a series of payments paid by the Lessee to the Lessor.

Lessee

The party who uses the leased equipment, makes the payments, and may deduct the same as an expense in computing taxable income.

Lessor

The party who is the owner of the leased equipment and receives the rental payments paid by the Lessee.

Open-End Lease

This type of lease is called Open-End because it is the least restrictive kind of lease. The terms of the lease and the residual value amount are customized with the client based on the type of vehicle and usage. At the end of the lease, based on the Guaranteed Residual amount, there are options for the Lessee to exchange, return, or purchase the vehicle. An option to extend the lease at the end of term is usually available. The Open-End Lease also becomes an attractive form of freeing up cash through a financing option known as a Lease Back.

Guaranteed Residual

For most Lessees, the main advantage of lease financing compared to loan financing is the establishment of the Residual Value, which results in a lower monthly payment. The residual is the non-depreciated amount remaining at the end of the lease. In a typical finance agreement, the vehicle or equipment has to be fully paid for during the term of the financial commitment. With a lease, it is recognized that the asset may well have value at the end of the financing term and this amount does not need to be amortized in the monthly payment. It is important to note that with a Guaranteed Residual, the Lessee shares risk with the Lessor. Once the residual is established, this amount has to be satisfied by the Lessee at end of the lease term either as a purchase of the leased asset or by returning the asset with a value equal to or greater than the residual. It is important, therefore, that the Residual Value that is set at the start of the lease is matched to market conditions and the expected use of the vehicle or equipment. There are definite advantages to this type of lease. A Residual Value lease has no wear and tear charges, damage penalties, or mileage penalties. If, at the end of the term, the leased asset is worth more than the Residual Value, the Lessee is entitled to this lease equity. And, because the Lessee shares at the end of term risk, the lease can be more flexible and the payment lower than a comparable Closed-End lease.

Closed-End Lease

The Lessee is obligated to pay the lease payments and return the leased vehicle upon expiry in excellent condition (subject to "normal" vehicle wear and tear). Usually contains a penalty/payment obligation if certain predetermined usage "hurdles" is exceeded (i.e. mileage restrictions and condition).

PAP

Represents Pre-Authorized Payment Plan and is a program whereby the Lessee authorizes the Lessor to debit its bank account for the required remittances on the lease contract.

Residual Value

The estimated value of the leased asset at the end of the lease term. For most Lessees, the main advantage of lease financing compared to loan financing is the establishment of the Residual Value, which results in a lower monthly payment. The residual is the non-depreciated amount remaining at the end of the lease. In a typical finance agreement, the vehicle or equipment has to be fully paid for during the term of the financial commitment. With a lease, it is recognized that the asset may well have value at the end of the financing term and this amount does not need to be amortized in the monthly payment.

Term

The period of time during which the Lessee is entitled to use the equipment.

Insurance

The Lessee is required to maintain, at their expense, the stipulated insurance coverage, whether the vehicle is used or not, during the lease term and until the vehicle is returned or purchased.

Taxes

The taxes the Lessor must add to any payment or purchase, which may include federal excise taxes and fuel consumption tax.

Personal Property Security Act (P.P.S.A.)

Allows for a public record of an owner’s or creditor’s interest in an asset and establishes the priority of claims. The Lessor will register its interest in the leased asset with the government. The amount charged is the cost of registration, which varies with the length of the term.

Security Deposit

A non-interest bearing refundable amount of money that will be held by the Lessor to ensure the performance of all terms, conditions, and obligations under the lease agreement. The Lessor has the right to deduct from such security deposit any amounts owing under the lease that the Lessee has not paid to the Lessor. If any of the security deposit remains, the Lessor will refund those funds to the Lessee upon the termination of the lease.

Lease Back

This is a type of lease financing in which the Lessor purchases an asset that already belongs to the Lessee for the purpose of leasing it back to the original owner. This option is common for businesses and professionals wanting to free up cash without using existing bank lines or taking on additional bank financing. This option may also be used as a strategy for reducing taxes and should be discussed with your tax or accounting professional.