Finance Types in more detail
You rent the vehicle from a lessor over an agreed period. The lessor will usually sell the vehicle as second hand when you hand it back, so the lease payments can be kept low because the full asset value does not need to be recovered by the lessor during your rental period. At the end of your lease, you either return it to the lessor or ask if an extension to the term can be offered if you need to keep it a little longer.
It is worth adding maintenance services and possibly tyres into your agreement if you expect to do high mileage – and always try to forecast accurate mileage, as paying excess mileage charges at the end can be crippling. Some agreements can have the mileage renegotiated – usually if if under halfway though the overall term.
A Business contract hire rate is quoted excluding VAT, a Personal Contract hire rate is quoted inc’ VAT. Bear in mind VAT can change during your rental term, this changing your monthly rentals. The Government is the body to announce any change in VAT.
You pay VAT on contract hire as you are paying for a rental service, you do not pay VAT on PCP as you are borrowing money in a PCP, not paying for a vat-able service such as a vehicle rental..i.e. contract hire/lease.
If you want an option to own the vehicle at the end you may prefer to go for contract purchase (or PCP if you are a private buyer)
Very similar to contract hire but you get the option to own the vehicle at the end by paying the balloon. The vehicle is owned by the lessor until the final payment is made at the end of the term. If you decide not to make the balloon payment the vehicle is returned to the leasing company.
A form of HP but with an obligatory (not optional) single large payment at the end of the term. Once you make that final obligatory payment the legal title of ownership transfers to you
Suitable for high-value vehicles as you take on the residual value built into the calculation. Higher residual values mean lower monthly payments but a larger sum to pay at the end. It is therefore fine for you or your business if you want to retain the vehicle as an asset at the end of the term.
For businesses, the vehicle can appear as a balance sheet item and you can write down the value against taxable profits. Once the balloon payment is made, the vehicle is yours. Some lease purchase packages also offer a maintenance package for the duration of the lease purchase agreement.
There are disadvantages to lease purchase too, including:
- Balloon payment – You must have sufficient finance to afford the balloon payment at the end of the contractual period because it is not optional. In some cases it can be higher than the residual value.
- VAT not recoverable if you are a business - you can only reclaim VAT if the car is used only for business use.
- The vehicle is yours so the effects of depreciation and the costs of maintenance and disposal are risks.
- For private drivers, it may be suited to those who like no mileage tie-ins as you can set it at any level depending on how high or low you want the residual value/balloon amount to be.
You simply borrow the cost of the vehicle (beyond any deposit you can put down), pay it off monthly and the vehicle is yours once you’ve made the final payment.
You are paying off the whole loan and the car is yours at the end of the term. Although monthly PCP payments are lower than HP, your overall cost will be lower with HP if you can afford to pay it each month.
Personal Contract Purchase (PCP)
PCP offers lower monthly payments as you are only paying off the amount between the purchase price (less any deposit you pay) and the final balloon figure in your agreement, you are not paying off the whole amount (as in HP deals) and you get the choice of keeping the car at the end or not.
Agreements can usually be run with anywhere between 0 - 40% of the vehicle price as a deposit.
A PCP quote will include a monthly payment, an APR %, and a final balloon payment (“guaranteed final purchase price”..or “GFV” - guaranteed final value). This is the amount you’ll have to pay at the end if you want to keep the car and is the value the funder has forecast for it if your mileage forecast has been accurate (and it is clearly better to build in enough mileage allowance at the start than have to pay for excess mileage at the end!).
If you hand the car back at the end of the term instead, you have nothing further to pay (if the dealer inspecting it finds no faults requiring repair/refurbishment) but if its subsequent re-sale then realises a greater amount than the GFV figure in your agreement, you’ll get that surplus which you can then use towards your next car. However, funders will have varying methodologies so please check your small print to check how your own deal will work.
You can often build in maintenance packages if you might have high mileage.
So, what am I paying off with PCP?
With PCP you are only paying off the amount which is the difference between the purchase price (less any deposit you’ve put down) and the GFV offered by the funder, so you are only paying interest on that difference figure, not the whole price of the car.
Surely I just need to look for a low APR rate?
Not always. Everyone is APR-sensitive but with PCP you need to look at all elements of the deal, not just the APR.
You can have a low APR but those deals usually come with a low GFV figure too, so the difference (the gap between the purchase price and GFV) is large and that is the figure you are paying off. Get quotes with reasonable APR’s and then check the GFV figures...they will vary, so you need a balance between decent APR and the lowest difference between the price for the car and GFV figure.
The optimum PCP deal is a low APR and small gap between purchase price and GFV! Look for the monthly payment and the ‘total amount payable’ figure to help you make your decision, never just look at the APR.
Also watch out for any additional fees i.e credit arrangement fees (at the start and/or at the end of the term), ‘option to purchase’ fees, and excess mileage charges (always be realistic with your mileage estimates at the beginning and build in a little leeway in case you change jobs or move house and need to do more mileage).
Clearly, the more deposit you can put down, the less you’ll be needing to fund, but most PCP funders will stipulate maximum deposits, often a max’ of somewhere between 30-40% of the purchase price.
What about car manufacturer finance deals?
Yes...a good source of short term PCP offers so look out for them..but again don’t be sold on a deposit contribution offer or just a low APR...look at the overall deal as it may require you to pay a higher price for the car to start with and ALWAYS get an independent quote and compare the overall finance payable figures right to the end of the term, including any fees before making a decision
General Great Advice!
Always estimate your annual mileage as accurately as you can and build in some leeway. Better to do that than pay high excess mileage charges at the end. Your job could change or you could move house….many things could affect your mileage within 3-4 years.
Ask if re-contracting is possible during the term…this may assist you if you do suddenly change lifestyle and need at adjust the mileage in the agreement halfway through. Some deals allow it, others don’t.
If you think you’ll do more than 17,000 - 20,000 miles per annum ask about a maintenance agreement – as building that in could be cheaper over the term than paying for mileage-initiated servicing yourself.
Watch out for hidden charges – ask if there are any credit arrangement fees and at what points they become payable? Also ask about any additional Option to Purchase fees at the end of the term.
When looking at a manufacturer/dealer finance offer ALWAYS get a third party comparative quote. No matter how good an APR offer looks, the other elements of the deal may not be so good and give you a poor overall end total amount payable. Don’t get hung up JUST on the APR, you need to balance all elements of the deal. You can get very low APR’s but the total payable over, say 3yrs, will still be more than if you’d taken a slightly higher APR with a better balance in the balloon payment etc.
Other ideas if needing vehicles for a business:
Usually used by VAT-registered businesses - the vehicle is owned by the lessor still, but the payments are calculated to include the full cost of owning the vehicle.
There are also some finance leases where a balloon payment might be offered to keep your repayments low. At the end of the term when the vehicle is sold by the lessor, the lessee will share a %’age of the achieved sale (this could be a profit OR a loss!). There may be an option to extend the rental period at the end of the term depending on the percentage of any balloon included in the initial leasing term.
In the instance described above, although you never take ownership, a payment equivalent to the residual value is payable at the end of the lease.
Some finance lease companies may offer you the chance to extend the finance lease with a secondary rental.
So, overall..low monthly costs and initial outlay and up to 50% of the VAT payments can be claimed by the business with the vehicle able to be shown on the balance sheet..BUT you will never take ownership of the vehicle as the car or van must be sold to a third party and interest rates can vary between funders and you must watch out for hidden costs such as documentation fees, which are paid at the outset and often set aside as a cost so as to make the monthly amount appear as small as possible.
Sale and Leaseback
If a business needs some capital, and it already owns some vehicles, this could help.
You agree a value with a buyer (usually a leasing company) and then sell the vehicles to the buyer who then leases them back to you. This gives you immediate cash and allows you to use more of a traditional contract hire arrangement, and you no longer have to worry about further depreciation.
You pay the difference between the current value and the future (residual) value in monthly instalments as a contract hire, releasing pressure on your balance sheet assets.
Key differences between leasing and purchasing for a business:
Leasing (contract hire and finance leases) repayments are 100% fully tax allowable unlike outright purchase options where only the capital allowances can be claimed against tax. If the purchase was made via a Lease/Contract purchase or a bank loan, the interest charges can be reclaimed against tax also.
With purchase options VAT is payable up-front, but with contract hire and finance leases the VAT is payable over the term - so further protecting your cash-flow.
Credit and debt status
Contract hire options protect the credit status of a business as the lease payments are usually shown as an expense, not a debt (contract hire is regarded as “off balance sheet”).
If purchased (outright or with lease purchase) or using a finance lease, it will show on the balance sheet as it is owned by your business. Contract hire keeps vehicles acquired in this way off the balance sheet so protecting your credit status.