Automobile and Equipment Leasing
Automobile and equipment leasing offer many advantages like the acquisition of the car or the piece of equipment without having to pay too much of a down payment. The lease contract can be structured by a specialized attorney to take advantage of the lease as a tax deduction or a business expense, plus the important advantage of showing a better balance sheet because some of the lease commitments can be kept by creative accounting as an off-balance-sheet commitment.
The riba-based lease is structured based on three important factors:
1. The prevailing interest rate.
2. The purchase price at the beginning of the lease, which is taken as the current market value at the beginning of the lease.
3. The projected value of the car or the piece of equipment at the end of the lease which may be in two, three, or five years. This value is obtained by assuming a depreciation schedule for the car or the equipment.
Most leases, if not all, are riba-based financial leases. The finance company owns title to the car or the equipment and keeps its name on the title. It leases it to the user at a monthly rate that will include a finance charge portion based on the interest rate used to calculate the monthly payment. At the end of the lease, the customer returns the car or the piece of equipment and he walks away. However, the customer may be responsible for any excessive wear and tear over and above what was expected by the leasing company, the owner of the item leased. Examples are excessive miles driven over and above the agreed-upon limited miles per year, any paint and/or body damage, and any damage to the tires, car engine, and car systems over and above usual use.
The problem with leasing (also called financial leasing) in RF finance is the problem of renting money and not renting the use of the car. That rent of money at an interest rate does not change from car to car or from a geographical location to another — one with a vibrant economy and another with a weak economy, depending on the supply/demand and utility factors but it is dependent on the going interest rate on the day of the agreement. In the LARIBA RF model, we use the prevailing market lease rate from sources such as national car rental companies. The other problem is the projection of the depreciated car price three years or five years in the future on which the future value of the item is estimated. Only God knows what the price of an item will be a few days later, let alone if it is three or five years later. RF discipline requires that the price should be marked-to-market at the time of the termination of the lease and that should be the price used to figure out the monthly payments using the FARIBA RF finance model.
With the LARIBA RF finance model, the monthly payments over a five-year period would not be much different from the lease rate but at the end the customer owns the car or the equipment and does not have to go through the cost and inconvenience of estimating the item over utilization and the cost of replacing the overused items and the excess miles driven.