A fair value option is the right to buy a leased item at fair market value at the conclusion of the lease term. It is not an obligation to buy, but rather a safeguard for all parties involved. The option helps the owner to get a fair price while the buyer is less likely to be overcharged. This type of option is used frequently with real estate, cars, and high-priced equipment. Risks associated with using this method of financing depend upon the volatility of the market and specific characteristics of the leased item.
The price of the item is not determined when the fair value option is granted. This is because the fair market value will usually change during the lease period. The figure is typically determined once the lessee has communicated intent to buy.
A lease with a fair value option often has lower payments. This is primarily because the customer is not seen as having the burden of ownership. Conversely, the customer also does not get some of the benefits of ownership, such as tax write-offs.
Customers with a fair value option usually have three options at the end of a lease term. They can return the item to the owner, sign a contract for a new lease, or buy the item at fair market value. If a customer chooses to sign a new lease, it is possible that the terms will change, but it can be in the owner’s best interest to continue to extend the fair value option. This is primarily the case with items that can increase in value, such as real estate.
Once a lessee has decided to exercise a fair value option, there are several factors considered when determining the fair market value of an item. Some of the most common are supply versus demand, the current cost of replacing the item, and the price of similar items. Other factors that may be considered include the cost of maintaining the item, risks of ownership, and the expected return on investment.
The fixed price purchase option is an alternative for buyers who wish to avoid the uncertainty of a price calculated with the fair value option. With this option, the sales price is determined before the end of the lease term. This amount is typically based on a forecasted future value. Depending on market activity, it can be risky for either the buyer or seller. For this reason, the fixed price option tends to be less popular.