Whatever happened to car hire purchase?
Why has this method of financing cars that was so popular, lost its appeal over the past ten years? Certainly it was most company's first choice when it came to purchasing company cars. One way or another it seemed very important to them that they eventually owned the vehicles. Car leasing has been around for quite some time but for a long time many companies resisted this form of finance.
If you consider the interest differential between the funds on deposit and what they will pay in interest for example on a hire purchase agreement it doesn't particularly make financial sense. So why do companies often take out a vehicle leasing contract when they have the money sitting in the bank?
The reason that companies in this financial position opt to keep their money in the bank is sometimes because it can be just too painful to put the company's hard earned money into a vehicle, which is after all a depreciating asset, when it can be leased so inexpensively. An example would be paying just over 54,000 for a new BMW when the vehicle could be available for 850 per month with thirty six months contract hire. The outlay would be as follows, three payments in advance 2,550, plus 35 payments of 850, a total of 32,300. A difference of 21,000 in outlay over the term and by taking finance the company has kept its capital on deposit and in reserve, for unforeseen events.
If the company uses its cash to purchase the car, what would it be worth at the end 3 years? It's a question to which nobody has the answer but with the uncertainties that there are in the world, why gamble when you can let someone else take the gamble on future values?
Companies however started to do the sums and realise that if contract hire improved their cash flow, was more flexible and allowed them to borrow off balance sheet, then did it really matter that they didn't own the company vehicles? Then there were occasions when the residual value of vehicles was extremely hard hit, most recently in 2008 and companies started seeing vehicle ownership as more of liability than a benefit, particularly as it is the contract hire company that suffers the loss when residual values drop.
Second hand cars can often be difficult and time consuming to sell. Furthermore at the time of disposal the vehicles are usually outside the warranty, so you always run the risk that an engine is going to blow up or some other fault develops and the purchaser returns it to you claiming it was faulty when it was sold. You can dispose of vehicles through the trade but that carries with it its own financial penalties; the significantly lower price you have to accept for a car when you sell it to the trade.
Another worry with regard to leasing was being tied to a three year term and suffering high penalties if there were a change in the company's circumstances and they wanted to cancel the contract. Of course if you try and settle a hire purchase agreement early, you will also be penalised, because most car finance companies will use what is know as The Rule of 78 to calculate the settlement, which can make it very expensive to settle an agreement early.
So what should companies do? It's very much an individual decision but there can be a very nice feeling about keeping your capital in the bank and an even nicer feeling, handing back a car to the contract hire company, knowing it has plunged in value.
Tagged with: car • Car Finance • contract hire • hire purchase
Filed under: Car Finance