3 basic forms of leasing explained

There are three basic forms of leasing – hire purchase, finance lease and contract hire.

What is hire purchase?

Also known as lease purchase, most people will have come across this at some point in the high street. Whether you are considering buying a car or a television, hire purchase is widely available.

It allows you to pay off the full amount over a defined period. At the end of that period, provided you stick to the terms of the agreement, you will own the asset.

There is a capital allowance – currently 25% on the reducing balance – available under a hire purchase agreement. If your business is registered for VAT, you can also claim back the VAT on the asset upfront. Also, any interest that you pay can be offset against profits. At the end of the agreement, you will own the asset.

However, despite this, hire purchase is far less common in business transactions now than 10 years ago.

“If you see it as an asset that will keep its value, hire purchase is for you,” explained Roberts. But it does depend on what you want to do with the asset. Most businesses want to use but not necessarily own the equipment. In fact, small businesses are increasingly relying on full-service leasing contracts that allow them to use the asset without any of the hassles of ownership.

The trend has spread from cars and vehicles, but is growing in other areas, such as IT, explained the FLA’s Pickering. Small companies, in particular, do not have time to keep up to date with all the latest technology and what products are on offer. Instead, you can bundle the service in with the lease and ensure that somebody else keeps up to date for you.

There is another reason that small businesses may have turned away from hire purchase. A start-up business that has yet to turn in any significant profits may not be able to make best use of capital allowances, says Roberts. Instead, the bank or finance company can take advantage of those allowances and pass on the benefit through lower rentals.

What is finance lease?

Although a finance lease will look and feel the same as a hire purchase, you will not end up owning the asset at the end of the contract. Ownership remains with the finance company at all times.

The agreement is structured so that you pay off the whole value of the asset. If you leasing a car worth £10,000, you will pay the whole £10,000 plus interest during the lease. If you are still using the asset at the end of the original contract, a second agreement can be entered. This secondary agreement will be for a nominal fee.

You will be able to offset rental charges against profits and you are able to claim VAT as well. The agreements can be structured in different ways but you may find that you can choose when to sell the asset and, if so, get a rebate for the remaining rental charges.

What is contract hire?

This offers you an opportunity to have the use of a piece of equipment, often tied in with a maintenance contract, for the duration of the agreement. Ownership remains with the finance company and you will pay a set fee over a period to use that equipment. The contract will outline a residual value at which the finance company will take back the equipment at the end of the contract.

You could find this cheaper than a finance lease. If, for example, you wanted to buy a car for £10,000, a finance lease would be structured to pay off the whole amount plus interest over a period of, say, five years.

However, under contract hire, the contract will specify a residual value that the goods will be worth at the end of the lease. Using our example of a £10,000 car, the contract may specify a residual value of £2,000 at the end of a five year lease. You will pay a total of £8,000 plus interest for the use of the car during that time.

For this reason, maintenance can be tied in to the contract to ensure that the asset will have the required residual value.

One of the big benefits of contract hire to a small business is that there is no large capital outlay for equipment that could damage the company’s balance sheet. While your business needs certain equipment, through a contract hire agreement only the rental charges will be shown on the balance sheet which should make it more attractive.

Although a finance lease will look and feel the same as a hire purchase, you will not end up owning the asset at the end of the contract.