Car leasing allows you to get the use of a vehicle without taking ownership
of it.
You lease the car over a period of time (known as the 'term') during which the vehicle
is still owned by the leasing company (the 'lessor') but is rented to you (the 'lessee').
Effectively car leasing is borrowing the vehicle from someone for a fixed
period in return for a monthly payment.
Car Leasing Explained
During the car lease period you pay a monthly rental to the leasing company.
The monthly rental covers
the costs incurred by the leasing company to operate the vehicle, plus a profit for them too.
In other words, you pay the leasing company for:
- Depreciation in the value of the car over the life of the lease
-
Vehicle Excise Duty (the 'tax disc')
- Interest Charges on the money borrowed by the car leasing company to buy the vehicle
- The leasing company's profit margin (which might be just the interest charges but could also include something in the final value of the car)
- VAT on the rentals
Optionally you may also be able to include a contract to maintain the car for you as well.
What Happens When The Car Lease Ends?
At the end of the car lease you return the vehicle to the leasing
company. The leasing company sells the car and takes any profit or loss
on the sale.
What Do You Pay For in Car Leasing?
With car leasing you are basically paying for depreciation and interest, but because you only pay back the depreciation part of the car's price the interest included in a car leasing deal is usually more than in an equivalent hire purchase deal.
This is because each monthly car leasing payment only reduces the outstanding balance of the car's purchase price by a proportion of the forecast depreciation, not the full purchase price.
For example, you use car leasing for a car costing £30,000. The leasing company expects it will be worth £10,000 at the end of the lease, so it will depreciate by £20,000 (£30,000 - £10,000).
In each monthly car leasing payment you pay back a proportion of the £20,000 depreciation, plus interest on the amount outstanding.
As you are only paying back the £20,000 depreciation, not the full £30,000 purchase price, there is more of the original purchase price left outstanding each month so there is more interest to pay on this.
By comparison, a traditional car hire purchase agreement repays a proportion of the total cost of the car each month.
This means the balance outstanding is less as you progress through the monthly payments and the interest charges are also correspondingly less.
However, repaying a lower amount of the purchase price each month means that the actual monthly payments are lower in car leasing than for hire purchase.
Advantages of Car Leasing
Because the leasing company recovers VAT on the price of the vehicle the rentals for
passenger cars will be lower than comparable finance instalments for Personal Contract Purchase (PCP), even though the leasing company must add VAT to the monthly rentals.
Because the vehicle is leased, the normal responsibilities of ownership, such as sourcing
the best deal and obtaining the best resale (or 'residual') value, are avoided, as
is the risk of the residual value being less than expected.
In effect, you simply operate the vehicle rather than owning it, so car leasing is sometimes referred to as an 'operating lease'
Disadvantages of Car Leasing
If the lease agreement is terminated earlier than expected then you will usually be required to pay a penalty (usually a number of months' rentals).
In addition, if the vehicle is returned with more mileage than that agreed for the term of the lease, or is not in a condition appropriate for it's age and the lease mileage, then 'end of contract' surcharges may be made by the leasing company to cover the excess mileage or wear and tear.
Should You Lease A Car Lease or Buy?
This will depend on on your financial circumstances and whether or not you prefer the fixed costs of car leasing.
Basically, if you don't like the risk of car ownership (depreciation costs) then a lease will avoid any unforseen downturns in the used car market.
But the reverse is true too - if you take care of your cars and keep them maintained then you could make more money by buying your cars and eventually selling them for a better price than the market average.
To see the cost impact of leasing or buying your next new car click here.