Graduated leases involve changing monthly payments at specific points during the lease term. They are often used to finance real estate and benefit lenders more than borrowers. Tiered payment lease plans are also used for machinery or equipment purchases.
A graduated lease is a rental financing arrangement in which monthly rental payments change at specific points during the lease term. Consumers and businesses often enter into leases because lease payments are often less expensive than purchase loan payments. Many types of leases have fixed monthly payments, but the payment terms of a graduated lease mean that the lender has the ability to increase the tenant’s payments during the rental term.
Business owners often use graduated leases to finance real estate. Historically, property and real estate prices tend to increase over time. In a standard graduated lease, the owner or finance provider re-evaluates the financed property multiple times during the lease term. Each time the value of the property increases, the finance provider can increase the lease payments so that the cost of the entire lease always amounts to a certain percentage of the value of the property. Lenders typically give borrowers lease terms that last between 10 and 30 years; Financed properties are typically appraised at least once every five years under a graduated lease.
Lenders benefit from graduated leases because the borrower ends up paying the going market rate to rent the property, regardless of the property’s value at the beginning of the financing term. If property prices rise steadily over a 10-year period, someone with a 10-year fixed-payment lease would pay less per month than someone who leased within the last year. Therefore, graduated arrangements benefit lenders rather than borrowers. Graduated agreements are generally not used to finance vehicles because vehicles depreciate in value over time and therefore lease payments would need to be adjusted downward if vehicles are reassessed. Consequently, few lenders offer phased financing for collateral depreciation since such an arrangement would benefit the borrower more than the lender.
While changes in many lease payments depend on the increase in the value of the collateral, some graduated leases are structured so that monthly payments increase over the rental term, regardless of the value of the property being financed. These agreements are sometimes called tiered payment lease plans. Small business owners often use tiered payment plans to purchase machinery or equipment that will help the business generate an eventual profit rather than an immediate return on investment. A manufacturing company can use a step lease to finance the purchase of a machine that produces goods. The lender may allow the manufacturing company to make minimum payments for a set period of time, but once the goods have been produced and marketed, the payments increase and may continue to increase for the remainder of the term.
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