'What is car leasing?' FAQ on car leasing and contract hire
Author: Robin Brown
Published: 08 August 2008
Car leasing is a complex issue, with motorists often struggling to understand exactly what constitutes car leasing and what the benefits of leasing a car are. With this in mind we've provided a simple FAQ guide on car leasing, which should explain the basics of how leasing - including PCP, contract hire, and finance leases - works.
Understanding car leasing fully can equip you with the knowledge to get a much better leasing deal on a new car, avoid some potential pitfalls and know where you stand when you enter a leasing contract.
And if you have any questions you don't think we've covered, drop us aline using the comments form at the bottom and we'lll try to enter them.
What is car leasing?
Leasing is a generic term that describes various methods of using a new car that you do not own. When you lease a vehicle you will agree a set amount of time with your dealership or finance provider that you will have the car.
At the end of the period you give the car back to the dealer and you can walk straight into another deal without the hassle of selling a vehicle.
Leasing can variously describe business contract hire (BCH), personal contract purchase (PCP), finance leasing, personal contract hire (PCH), hire purchase/lease purchase and contract hire. All of these terms describe various methods for leasing a vehicle.
How does leasing work?
When you agree a price on leasing a car you are agreeing to pay the difference between the agreed price for the car and the predicted residual value of the car at the end of the contract. If you had bought the car outright your new car would have depreciated by this amount.
With leasing you have the option of walking away from the car at the end of the contract. Manufacturers will often subsidise the depreciation of the car by lowering the rate of finance over the term. This low rate finance means that you are in fact only paying a small portion of the depreciation.
Types of car leasing and finance alternatives
• Business Contract Hire
Lease a business car for an agreed period of time (usually between 24 to 48 months). Pay an agreed fixed monthly instalment and the predicted depreciation of the vehicle plus interest.
• Personal Contract Hire
Lease a car for personal use for an agreed period of time (usually between 24 to 48 months). Pay an agreed fixed monthly instalment and the predicted depreciation of the vehicle plus interest.
• Finance Lease
A lease covering only the finance element of the vehicle. The customer pays back the entire capital cost of the vehicle plus charges over a period of time, or they may agree to a balloon payment to reduce the monthly instalments.
• Hire purchase
The customer pays a deposit, and then pays off the balance in monthly instalments over an agreed period of time. The size of the deposit paid, the length of the contract and the sale price of the vehicle determine the monthly payment.
• Personal Contract Purchase
Personal contract purchase (PCP) is similar to contract hire where an individual can lease a vehicle (subject to status) for a fixed monthly payment usually from 12-48 months with a low initial payment with a fixed mileage over an agreed period.
PCP is more of a hire purchase/leasing agreement. While this is very similar to leasing the customer does have the option to buy the vehicle at the end.
PCP is very popular with ex-company car drivers as many schemes include servicing and maintenance costs in the quoted price.
Why would I choose to lease a car?
Leasing a car cuts out one of the biggest problems with buying a new car - the loss of value inherent in buying a new car. The majority of new cars will lose around 50 per cent or more of their original value. Leasing cuts out the problem of depreciation inherent in owning a new car.
What are the potential advantages of leasing a car?
When you lease a car you will be expected to make a payment equivalent to three or four months' payments. This will amount to a small percentage of the car's overall value. As a result leasing offer the option of paying a small amount upfront.
Leasing may offer you the alternative to drive vehicles you cannot afford to buy via other methods. Additionally, more prestigious vehicles will have a higher residual value at the end of the contract, meaning a proportionately smaller monthly fee.
At the end of the contract you can walk away from the car, choose to buy it outright or lease another brand new vehicle.
Vehicles are often subject to excellent leasing deals that may be a result of the manufacturer's desire to clear stock. Low-cost contracts and add-ons such as maintenance or road tax can often be found online.
What are the disadvantages of leasing a car?
With leasing you will not own the car - unless you choose to retain the car at the end of the contract. If you default on payments over the course of your contract your car can be repossessed.
When you lease a car you will agree to maximum yearly mileages. Charges for exceeding these annual mileages can result in stiff penalties. You may be charged for any damage to the car when you return it. If you do not pay for a contract with maintenance you'll have to stump up for that too.
As the car is not yours you will be expected to take out a comprehensive insurance policy. This may me a significant financial commitment depending on your income.
If you want to return the car before the end of the contract you may be charged a fee.
What sort of people benefit most from leasing?
Those who benefit most from leasing will be sure of a regular monthly income, be keen to change their car on a regular basis and be keen to pay lower monthly payments than buying a new car outright.
Getting good deals on leasing
What makes a good leasing deal?
It's worth shopping around to see what deals are available, from manufacturers, dealers and brokers. Look out for low monthly payment deals, deals with inclusive extras such as road tax and maintenance and a good guaranteed residual value. Remember, the higher the residual value at the end of the term, the lower your monthly payments will be.
How do I get a good deal?
Try and predict when manufacturers and dealer could be keen to shift stock. The end of the month, quarter or year might be a good time to try, as dealers are looking to hit targets.
Alternatively the run out of a model in preparation for a replacement - such as the Vauxhall Insignia replacing the outgoing Vectra - might mean good deals on the outgoing model. Be aware that residual values may be lower on the kind of vehicles likely to be discounted.
Consider the overall cost of the car, the Minimum Guaranteed Future Value - see below - and the the APR. These three factors will determine how much you will pay. As residual values and APRs are liable to fluctuate, you must bear in mind prevailing market conditions.
How do I make sure I won't lose money on a car's value?
Taking out a PCP or business contract deal guarantees a future minimum value, meaning you won't fall into negative equity. The Minimum Guaranteed Future Value - see below - of the car is binding under the Consumer Credit Act, meaning that the consumer is protected at all times.
Doesn't it make more sense just to take out a personal loan?
While you will own the car yourself you will pay a sum greater than the actual cost of the car, and APRs could vary greatly between loans, potentially becoming a very expensive way of buying a car. If you can't keep up the cost of the payments you'll lose the car, and potentially anything else on which the loan is secured.
Isn't leasing just for business customers? No. Anyone can lease a car and it is an option which makes more financial sense for many people over simply buying a car outright.
Where can I look at leasing deals?
There are hundreds of websites describing various leasing deals on the internet. Our sister site Askaprice.com has a wide selection of various leasing deals.
What kind of models have strong residual values.
Premium models such as BMW, Mercedes, Audi, Jaguar, Volvo, Saab and Lexus are likely to have stronger residual values than other mass-market manufacturers. Although in certain circumstances, large leasing providers will often bulk buy stock of vehicles to help reduce the costs of leasing these mass-market manufacturers.
Car leasing FAQ
Who pays for servicing and road tax?
That depends on the deal - make sure you check the fine print and know who is responsible for these costs before you sign anything.
What about insurance?
You are responsible for paying insurance. Remember that you will need to take out a comprehensive insurance policy on a leased vehicle.
What other associated costs are there with leasing?
Delivery and registration fees are usually applicable although certain deals will often build this into the price for you. Always check that this is the case with the providers.
What is Minimum Guaranteed Future Value (MGFV)?
When you take out a contract purchase deal, the lease company guarantees the lowest amount the car will be worth at the end of the deal. This is called its minimum guaranteed future value (MGFV).
This is the minimum amount of money you will have to pay when contract ends if you want to buy your car. If the car is worth more than the MGFV at the end of the contract you can use the surplus towards another deal. Your monthly payments will be calculated on the basis of the MGFV plus your initial deposit, and will alter according to your predicted mileage and term of contract.
Some leasing deals do not guarantee a future value, and leave the buyer open to the potential of negative equity. Essentially you could be paying more to lease your vehicle over the contract term than the car is worth.
What happens if car values depreciate while I lease or hire the car?
You could end up tied into a contract where you are paying more than the actual value of the car.
What happens if I cannot meet monthly payments?
Contact the finance company. You may be able to work out another deal, or you may have to return the car, potentially incurring a fee. If you miss payments without contacting whoever has provided your finance, your car may be repossessed and your credit rating may be affected.
I need more help. Who can I contact?
• National Conciliation Service (NCS)
Chestnut House
32 North Street
Rugby
CV21 2AH
01788 538 317
• Consumers' Association
020 7830 6000
• Driver and Vehicle Licensing Agency
Customer Services Manager
DVLA
Swansea
SA7 0EE
01792 782523
• Scottish Motor Trade Association
3 Palmerston Place
Edinburgh
EH12 5AQ
0131 225 3643
Can't find an answer to your question? Send it to us below and we'll do our best to answer it.
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Hi There, This is a very informative article. I would like to add a point about finance lease:
I would never set the balloon payment higher than the predicted value of the vehicle at the end of the agreement. We WILL NOT knowingly put you into negative equity.
Other companies will do this to show you lower monthly payments. We try to make sure that you will not get any shocks at the end of the agreement.
If we estimate the future value of the vehicle to be let´s say £3500 ex vat we will set the balloon payment at £1000 to £500 below this. We can also set the balloon payment zero, this is called a fully amortised agreement. What this means to you is that once the vehicle is sold at the end of the term you get 95% of the sale value ex vat. You cannot buy the vehicle. You will never own the vehicle. Your old lease vehicle when you sell it becomes the equity for your next vehicle.
PLEASE BE VERY AWARE THAT THERE ARE SOME COMPANIES OUT THERE WHO WILL OFFER EXTREMELY LOW MONTHLY PAYMENTS, WHAT YOU WILL NOT KNOW IS THAT THE FINAL PAYMENT WILL BE MORE THAN THE VEHICLE IS WORTH.