Finance terms can be confusing. Different words or phrases are sometimes used to describe the same thing and the English is frequently far from everyday. We hope this brief guide will go some way to explaining these terms. Many financial arrangements are made to make the best use of tax regulations, but, as we have no control over the Chancellor of the Exchequer, he may well change the regulations without consulting us. In all cases, check the current tax law with you accountant or bank manager who will also be familiar with your personal or company financial arrangements.
The piece of machinery or vehicle that is the subject of the financial arrangement. As this web site deals only in vehicles, the word vehicle will be used instead of asset.
The person who gets the use of the vehicle and who makes payments.
The finance company that arranges the lease and owns the vehicle.
There are many types of leases but as there are tax advantages, the lessee must be a business registered for VAT. A lease is therefore only available to a business, and not an individual. There are two basis types of lease, the Finance Lease and the Operating Lease.
A. The Finance Lease
A Finance Lease, includes terms such as Fully Amortised Lease, Fully Liquidating Finance Lease, Full Payout Lease, Fixed Term Lease, Balloon Lease, Flexible Term Lease.
The Fully Amortised Lease
Also known as a Fully Liquidating Finance Lease, A Full Payout Lease or a Fixed Term Lease.
The lessee pays the cost of the vehicle over an agreed period plus the interest charge. At the termination of the lease, the vehicle is sold to a third party and a proportion of the proceeds returned to him as refund of rentals. The lessee must therefore bear the risk of depreciation and although he may introduce the third party purchaser, he is not allowed to purchase the vehicle directly. As an alternative, he can extend the lease for a secondary period and be charged what is called a "Peppercorn" rent which is usually around 1% of the original purchase price.
The Balloon Lease
Also known as Balloon Financial Lease.
This type of lease allows for a lower rental charge with a large, or balloon, payment at the end of the term. Properly structured, the money from the sale of the vehicle by the lessor (the finance company) will provide the funds for this balloon payment. The lessee takes the depreciation risks and if the expected funds on sale are less than expected, he will be expected to find the balance. This type of lease is not suited to vehicles with volatile residuals, nor where a lease extension may be necessary.
The Flexible Term Lease
Also known as the Open Ended Lease or Flexible Finance Lease.
This allows for the lease to either run its full term or to be terminated early on agreed terms. The vehicle is then sold, profit over and above the settlement figure going to the lessee, but losses being made up by him. If the lease runs the full course, it can be followed by a secondary period as above.
B. An Operating Lease
This includes terms such as Contact Hire (with or without maintenance)
Contract Hire Without Maintenance
Also known as Operating Leasing, Closed End Leasing or Basic Contract Hire.
The lessee is charged a rental based on the depreciation charges over the period plus the finance charges. At the end of the period the vehicle returns to the finance company who have responsibility for the residual value. The finance company will insist upon terms concerning the mileage and mechanical condition to protect the value of its asset. These are known as the return conditions. Mechanical and physical condition remains the responsibility of the lessee but the burden of residual value goes to the finance company who should have the expertise to predict this more accurately.
Contract Hire With Maintenance
Also known as Full Service Leasing or Maintenance Leasing.
This is the same as Contract Hire with built in features that cover servicing, maintenance, tyres and sometimes insurance and road fund licences. The leasing company will often be able to negotiate lower prices for this work and should have a greater expertise in predicting the costs. For the lessee, budgeting is greatly simplified.
Also known as Lease Purchase.
Vehicle rental with the option to purchase on payment of a purchase option fee.
Things to Watch Out for:
- If my circumstances change, how can I get out of the contract and at what cost?
- If there is a balloon payment, how realistic is it in relation to the expected residual value of my vehicle?
- Is the expected mileage allowance realistic? What is the charge for exceeding it? Is this reasonable?
- If there are return conditions, do they seem reasonable in view of your normal treatment of vehicles?
- Is there any "small print" restricting what you thought was all inclusive maintenance?
- If the term "Agreed Residual Value" is used, (or a similar phrase) do you understand what it means? It may not mean that it is a guaranteed residual value but is a value the lessee and lessor puts on the vehicle for calculating end of contract financial arrangements.
- Who has set the value of any Balloon payment. To whose advantage is the acceptance of such a figure and how volatile could it be?
- Check the tax advantages and remember such things are changed at the whim of the Chancellor.
- Check on the proportion of rentals refunded from the disposal proceeds from a finance lease.
- Check on the peppercorn rental percentage at the end of a finance lease.
As mentioned earlier, tax regulations can change. Check with your bank manager or accountant what the current rules are and if they are appropriate for your circumstances. As a generalisation, when a vehicle is leased, it is deemed to be rented, so the payments to the finance company are treated as rent and allowances given on them. If a vehicle is financed under Hire Purchase, it is deemed to be a form of purchase and the tax allowances are given on the write down value of the vehicle.