Not sure what finance you need or don’t understand it, let us explain the types available to you.
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 vehicle finance where the vehicle remains the property of the finance company, with the vehicle effectively hired out to a business. The business can then use this asset while paying an effective rental rather than a repayment.
Finance lease differs from contract hire in that you usually ‘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 payments 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 end balloon payment (not necessarily the vehicle’s residual value). As a residual value is used to calculate your monthly rental, most finance lease companies will insist that you stick to a strict mileage limit as this mileage restriction is used to determine the future value.
You have full use of the vehicle during the finance lease period. 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 payment 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 agree to lease the vehicle again for a further period if you don’t wish to see it sold.
There are numerous benefits to acquiring a finance lease. These include:
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 payment options to suit your cash flow. You can make deferred payments, lowering the monthly rental with a balloon payment 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.
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.
There are disadvantages to finance leases too. Primarily these are that you will never take ownership of the vehicle as the car or van must be sold to a third party. A further disadvantage is that the hirer also takes on the administration and operating risk associated with the vehicle, including the road fund licence.
A finance lease removes the pressures of heavy initial outlays. It is a proven method of giving your business access to the latest vehicles without actually having to take ownership and buy them outright. There are also tax benefits too, which make this an ideal vehicle finance method for many businesses.
With Hire Purchase (HP) you reach an agreement with the supplier to pay an initial deposit, typically anything between 10% and 50%, and then pay off the balance in monthly instalments over an agreed period of time. At the end of this period, the vehicle is yours.
Unlike a lease agreement, the residual value of the vehicle is not taken into account. Instead your monthly payments on a HP agreement are determined by the retail price of the vehicle, the size of the deposit, the length of the contract and any interest payments.
In effect, the contract is between you and the lender but is normally arranged by the supplier. The lender effectively buys the vehicle and allows you to use it while you make payments. Only when all payments are complete is the vehicle officially yours.
The main advantage of a hire purchase agreement is that you can buy something you couldn’t otherwise afford.
Your monthly payments are effectively secured against your vehicle – and this has both pros and cons. Positively, this means you’re more likely to secure finance than you would be by shopping around for an unsecured loan as the lender has some ‘security’ in the form of your vehicle – this is often reflected in better interest rates.
HP is the traditional form of vehicle finance and is a good way of paying for a vehicle that you know you want to own at the end of the agreement and don’t mind paying extra per month to work towards ownership.
Lease Purchase works by the leasing company having a retail value of the vehicle and works out an estimated future value of the vehicle for the end of the contractual period based on its depreciation. This is known as the residual value. You can place a lump sum down-payment on the vehicle upfront and then you make monthly payments on the difference between the retail value and the residual value. As a consequence, the more the vehicle ‘holds its value’, the better the deal – meaning luxury vehicles are often popular for lease purchase deals.
With lease purchase you enter into an agreement to buy the vehicle at the end of the contract. There is no return option.
Therefore at the end of the lease period, the customer must make a final balloon payment. This may be done through a cash payment or alternatively with additional finance or a part-exchange.
A typical lease purchase agreement will last from two-four years, though with most companies it is possible to settle the agreement at any point during this period.
You should think carefully before entering into a lease purchase agreement because it is not necessarily the right method of car finance for everyone. Here are its advantages:
Luxury/prestige vehicles – Lease purchase is best suited to the finance of high-class vehicles due to the fact that you must take on the residual value. Higher residual values will also result in lower monthly payments.
Company asset – Lease purchase is ideal for companies that want to retain the vehicle as an asset.
Frees up finance – With lease purchase you take control of a vehicle while still holding money back to put into your company. Initial deposits are only usually the equivalent of three months’ payment.
Lower monthly payments – Payments are typically cheaper than hire purchase.
Balance sheet – The vehicle can appear as a balance sheet item and you can write down the value against taxable profits.
Ownership – Once the balloon payment is made, the vehicle is yours.
There are disadvantages to lease purchase too, including:
Road fund licence is not included as part of a Lease Purchase agreement.
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 – You can only reclaim VAT if the car is used exclusively for business use.
Ownership risk – The car is yours and thus the effects of depreciation and the costs of maintenance and disposal are all risks throughout the contract.
Business contract hire agreements allow a company to take on cars for a set period of time (usually between 12 months and four years) and pays via fixed monthly instalments. The company taking out the agreement doesn’t own the vehicles, however, so when the term of the contract is over, the cars are returned to the lease company.
The contract hire company will work out the ‘residual value’ of the vehicle – that is its value at the end of the contractual period once depreciation is taken into account. To estimate this value, the company will ask you to stick to a strict mileage limit while you drive the vehicle, and exceeding this limit could see you penalised at the end of the term.
To determine your payments, the company will deduct the estimated residual value from the retail price of the car, leaving you pay the difference in monthly instalments.
There are many different pros and cons of contract hire, and what may suit one business won’t necessarily suit all, but the chief advantages include:
Low initial payment – Unlike other forms of finance, typically business contract hire requires three monthly payments upfront.
Fixed monthly costs – For a set monthly payment, your business gets the use of a vehicle for an agreed duration and mileage that suits your needs. How much you pay each month will be determined by a number of factors, including the type of vehicle, the purchase price of the vehicle, mileage, and the estimated value of the car at the end of the contract (known as Residual Value). Therefore, the higher the residual value of the vehicle, the lower the business contract hire monthly payments.
Hassle free – For an additional monthly fee, you can ask your business contract hire company to take care of nearly every hassle associated with vehicle ownership, whether it is maintenance, servicing or replacement vehicles.
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. Vehicle leases do not have to be shown on a balance sheet, which will improve a company’s liquidity ratio, gearing and return on assets.
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 12 and 48 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.
Leasing company power – The major leasing companies purchase thousands of vehicles each year; therefore they are experts in negotiating substantial discounts with vehicle manufacturers. They can pass these savings on to you in the form of a competitive business contract hire rate.
Latest technology – Because your fleet will always comprise modern vehicles, your company could benefit from the latest fuel-saving developments in in-car technology.
Things to consider:-
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. Over estimate 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, however anything more severe could see you presented with a bill. Make yourself aware of what is considered fair wear and tear.
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