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What Is a Graduated Lease?

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  • Written By: K. Kinsella
  • Edited By: Shereen Skola
  • Last Modified Date: 24 November 2016
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A graduated lease is a rental financing agreement on which the periodic monthly rent payments are altered at specific points during the lease term. Consumers and businesses often enter into lease agreements because lease payments are typically less expensive than the payments on purchase loans. Many types of lease agreements have fixed monthly payments but the repayment terms on a graduated lease mean that the lender has the ability to raise the lessee's payments during the rental term.

Business owners often use graduated lease agreements to finance real estate. Historically, the prices of property and real estate tend to increase over time. In a standard graduated lease agreement, the property owner or finance provider reappraises the financed property several times during the lease term. Whenever the property value 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 property value. Typically, lenders provide borrowers with lease terms that last for between 10 and 30 years; financed properties are normally appraised at least once every five years under a graduated lease agreement.

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Lenders benefit from graduated lease agreements because the borrower ends up paying the going market rate to rent the property regardless of the property value at the start of the finance term. If property prices constantly rise over a 10-year period of time, someone with a 10-year-old fixed payment lease would pay less on a monthly basis than someone who took out a lease within the last year. Therefore, graduated agreements benefit lenders rather than borrowers. Graduated agreements are not typically used to finance vehicles because over the course of time, vehicles depreciate in value and therefore lease payments would have to be adjusted downwards if vehicles were reappraised. Consequently, few lenders offer graduated financing on depreciating collateral since such an agreement would benefit the borrower rather than the lender.

While changes in many lease payments are contingent upon the value of the collateral rising, some graduated lease agreements are structured so that monthly payments increase over the rental term regardless of the value of the property financed. These agreements are sometimes referred to as step payment lease plans. Small business owners often use step payment plans to purchase machinery or equipment that will help the company to generate an eventual profit rather than an immediate return on the investment. A manufacturing firm may use a step lease to finance the purchase of a machine that produces goods. The lender may allow the manufacturing firm to make minimal payments for a set period of time but once the goods have been produced and marketed, the payments increase and may continue to increase over the remainder of the term.

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