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Leasing Explained

Leasing gives you the chance to drive a new car every few years, with relatively low monthly payments and no worries about the car’s resale value. There are two main types of car leasing deals – personal contract hire (PCH) and personal contract purchase (PCP). Both come with strings attached, so make sure you understand how they work.

Restrictions when you lease a car

It’s good to compare APR rates, but make sure you look at the total repayment amount as well as balloon payments are not included in the APR rates.

Leasing a car is effectively long-term rental – you pay a fixed monthly fee to use the car for an agreed time period and number of miles.

Under a PCH agreement, you never own the vehicle and you have to hand it back at the end of the term. With a PCP agreement, you have the option to buy the vehicle at the end of the term in exchange for a balloon payment.

With PCP you also need to pay a deposit and with PCH you usually have to pay three months’ rental in advance.

As with all rental agreements, there are some restrictions you need to bear in mind If you cancel your contract and return the car you’ll probably have to pay a fee, or may even be liable to pay all the outstanding rental payments.You won’t be able to modify the car in any way – for example, adding a tow-bar – without permission. However, you can ask the leasing company to make modifications before you take it.If you exceed the agreed mileage, you’ll have to pay a penalty for this extra mileage at the end of the agreement.You must return the car in “good repair and condition” (taking into account “fair wear and tear”). So if, for example, your dog scratches the car, you may be charged to cover the cost of putting this damage right.If you plan on taking your car abroad, you may need to get written permission from the finance company each time you do so and there may also be a charge.

Choosing between personal contract hire (PCH) and personal contract purchase (PCP)

If you’ve taken out a PCP plan and intend to buy the car at the end of it, start saving up the balloon payment now.

People save money faster if they have a definite savings goal, so find out how to set a savings goal.

If you decide that leasing a car is your best option, here are the main points to consider when choosing between personal contract hire and personal contract purchase.

Non-fuel running costs: with PCH your monthly payment includes a maintenance package to cover non-fuel running costs, such as annual car tax (commonly known as road tax) and routine servicing. With PCP an optional maintenance package is sometimes available.

Monthly payments: these are generally lower for PCH than for PCP, although you often have to pay for the first three months in advance. The monthly payments for PCH also tend to be lower than for a personal car loan.

Freedom to change supplier at the end of the contract: with PCH you’re free to choose whether to start leasing a new car from the same company or shop around for a better deal elsewhere. Whereas with PCP you may have to stay with the same dealer to be able to use any remaining equity in your car as a deposit for a new car through PCP.

Worries about the car’s future: with PCH you don’t have to worry about depreciating value, warranty expiry, or selling it on – that’s the leasing company’s concern. The same applies to PCP, unless you’re planning to buy the car at the end of the contract (see below).

The big difference between PCP and PCH

Four out of five people with PCP plans don’t opt to buy the car at the end of their contract (Source: the Finance and Leasing Association).

Is it likely that you’ll be one of them? If so, leasing a car through personal contract hire (PCH) may work out cheaper for you.

The big difference between PCP and PCH is that PCP gives you the opportunity to buy the car and become its legal owner at the end of the leasing contract.

To do this, you have to pay a ‘balloon payment’ – also known as the Guaranteed Minimum Future Value (GMFV) – at the end of the contract. This is in addition to your deposit and monthly payments.

With PCP the total amount you repay in monthly instalments is based on an estimate of how much the car will lose in value though depreciation between the start and end of the contract.

If at the end of the contract you don’t want to buy the car, you simply hand it back. As long as the car is in good condition and hasn’t exceeded the agreed mileage, you won’t have to pay any more money.

With both PCH and PCP the lender can repossess the car without a court order. But for PCP, once you have paid at least a third of the total amount payable, they can’t repossess it without a court order.

Using your car as equity to lease a new car

Usually the finance company or car dealer will set up a PCP plan so that the balloon payment agreed at the start of the contract will be less than the car’s market value at the end of the contract. Assuming this difference in value still exists by the end of your plan, you can use the money as a deposit for leasing a new car through PCP.

Your rights if you want to cancel a PCP plan

Choosing the right PCP term is important. Opt for a lengthy period and you’ll end up paying more for the car. But if it’s too short, you’ll have higher monthly payments and could risk not being able to meet them.If you can’t keep up your payments or simply want to cut costs, you have the right under the Consumer Credit Act to return the car as long as you’ve already made half of your payments. This is called ‘voluntary termination’.

BUSINESS CONTRACT HIRE

Ideal for: Companies that change their car on a regular basis without the option to own the car

ADVANTAGES OF CONTRACT HIRE

VAT Payments - up to 50% of the VAT payments can be reclaimed.  This is only applicable if your business is VAT registered. You choose the model of car that you want. All you do is pay one fixed monthly fee, keeping your costs low and predictable. Hassle-free motoring. Running costs e.g. Maintenance and servicing can be included for easier budgeting. No risk of unexpected vehicle depreciation. Free up capital - Business contract hire is an efficient way of running a fleet of vehicles. Rather than tying capital up in depreciating vehicles the company is able to invest in other areas of the business. Currently, vehicle leases do not have to be shown on a balance sheet, which may improve a company's liquidity ratio, gearing and retaio and return of asset. Flexibility - Running a fleet using business contract hire gives the company flexibility to respond to changing market conditions. Business contract hire agreements are typically between 24 and 60 months long, which allows the fleet to respond to changes to staffing requirements more efficiently than through alternative funding methods. This flexibility can also help business’ respond to changes in their Corporate Social Responsibility (CSR) guidelines, for example switching fleet vehicles to greener, more fuel efficient models. Tax advantages - Some or all of the rental charge can be offset against taxable profits. Latest technology – Because your fleet will always comprise modern vehicles, your company could benefit from the latest fuel- saving developments in incar technology.

THINGS TO REMEMBER

Beware of excess mileage - Have an accurate idea of the vehicle’s annual mileage requirement, under estimate and you will face additional charges if the agreed mileage limit is exceeded. Overestimate and you be paying a higher monthly fee than you actually need. No option to buy - Unlike some forms of business car leasing, there is no option to buy at the end of the contract. Damage - Standard wear and tear is allowed, the vehicle should be returned to the leasing company in a condition that meets the BVRLA ‘Fair wear and tear’ guidelines, otherwise charges may be incurred.

FINANCE LEASE

Ideal for: Companies that need to tailor their monthly rental and require the optional flexibility of leasing the vehicle for a longer period

A finance lease is a method of financing a vehicle that is usually accessed by VAT-registered businesses and companies, however sole traders and partnerships can also take advantage of finance lease. It is a form of car finance where the vehicle remains the property of the finance company, with the vehicle effectively hired out to a business. Finance lease differs from contract hire in that you usually have a ‘balloon payment’ at the end of your lease agreement which pays off the leasing company’s investment. You agree how much your balloon payment will be, depending on whether you want higher or lower monthly rentals during the lease agreement.  The exact monthly rental is determined by the initial cost of the vehicle, the period of the finance lease, the residual value, and that end balloon rental (not necessarily the vehicle’s residual value).

At the end of the finance lease agreement the vehicle is sold to a third party by the finance company, if the sold price is above the pre-determined balloon rental then the finance company will refund a percentage of the proceeds back to the hirer, if the sale price is below the balloon payment then the hirer will be liable to make a further payment to the finance company. This way, a company with a finance lease agreement shares more of the risk of the vehicle but can also potentially profit if the car exceeds its RV, than if they took a contract hire deal. Alternatively you can lease the vehicle again for a further period if you don’t wish to see it sold.

ADVANTAGES OF FINANCE LEASE

Low monthly costs and initial outlay – One of the main reasons why companies take on finance leases is to avoid the initial hefty outlay.  Flexibility – Most finance lease companies will offer a number of rental options to suit your cash flow. You can make deferred rentals, lowering the monthly rental with a balloon rental at the end of the contract, or you can pay the entire cost in monthly instalments. Latest vehicles – You can gain access to the latest vehicles that would otherwise be unaffordable. VAT payments – Up to 50% of the VAT payments can be reclaimed. This is only applicable if your business is VAT registered. Balance sheet – Taking out a finance lease allows you to feature the vehicle on your balance sheet, and outstanding rentals are represented as a liability. Hire rental tax allowances can be applied for. Sales proceeds – You can boost your equity by receiving a proportion of the sale at the end of the finance lease term.

THINGS TO REMEMBER

You will not actually own the car.