Contract purchase is a way of getting a vehicle on finance but deferring part of
the repayments until the end of the finance agreement.
The finance agreement is usually set up with the intention that ownership of the vehicle will
eventually pass from the finance company to the buyer, principally to avoid
the tax drawbacks of contract
hire or leasing for vehicles with higher CO2 outputs.
In typical contract purchase arrangements the buyer is hire purchasing the
vehicle, i.e. hiring it for a period of time with a view to purchasing it once an
agreed number of payments or an agreed amount has been paid to the finance company.
The buyer will usually have an option to acquire the vehicle at the end of
the contract upon payment of the final balance of the purchase price (the 'settlement
There may also be a 'sales agency' agreement with the finance company for the finance
company to sell the vehicle on behalf of the buyer for a fixed fee at the
end of the contract, or for the finance company to repurchase the vehicle for an agreed
amount (a 'minimum guaranteed future value').
The contract may also allow the buyer to simply return the vehicle to the
finance company at the end of the agreement (though this may have implications for VAT under new rules being proposed at the time of publication - check back here for more information).
What's in Contract Purchase Payments?
Typically the finance company will source the vehicle and dispose of it at the end of the
contract. In addition, the finance company must fund the purchase as well. To cover
these costs the finance repayments comprise:
- Interest Charges
- The finance company's profit margin (which might be just the interest charges)
- Maintenance (Optional)
The finance company may include the Vehicle Excise Duty
or 'tax disc' renewal each year as a part of an optional service or maintenance contract.
Because the purchaser pays only for depreciation during the period of the finance agreement (the 'term'), as each monthly instalment is paid the payment reduces the outstanding amount financed at a much slower rate than in 'fully amortised' finance such as hire purchase.
Because less of the purchase price is repaid in each payment, assuming interest rates are the same in both
a hire purchase and a contract purchase agreement, the total interest charges in a contract purchase agreement are more than those in an equivalent hire purchase agreement (because more money is left unpaid during the term).
The overall costs of finance for a contract purchase agreement are therefore normally higher than those of traditional hire purchase.
However, repaying a lower amount of the purchase price each month means that the actual monthly payments are lower in contract purchase than for a fully amortised hire purchase agreement and therefore more 'affordable' each month.
Advantages of Contract Purchase
Because the finance repayments cover just depreciation, rather than the full purchase
price of the vehicle, the monthly repayments are less than those of Hire
In addition, at the end of the contract the buyer can take ownership of the
vehicle so it can profit from prudent management of the vehicle, such as achieving
a better resale price than expected.
With an optional purchase and resale agreement the costs of running the vehicle are
fixed during the replacement cycle, so the buyer can avoid unexpected costs.
Tax relief for the
buyer on cars with a CO2 output over 110g/km is not limited in the same way as leasing,
thereby reducing the total costs of contract purchase for cars with higher CO2 emissions compared to leasing, but there are deferrals of tax relief.
Disadvantages of Contract Purchase
If the contract is terminated earlier than expected then the buyer may be
required to pay a penalty (usually a fixed number of instalments or the difference
between the capital already repaid and the sales proceeds achieved on disposal of
Under accounting conventions applying at the date of publication, contract purchase
must be disclosed on the balance sheet of a business as a liability. This can worsen
the appearance of the financial position of a business.
For passenger cars (other than pool cars) VAT on the purchase price of the vehicle
cannot be recovered, so the finance instalments are higher than comparable rentals
for contract hire.