Contract Hire Explained – A Guide To The UK’s Most Popular Vehicle Funding Method

There has been a definite shift towards the contract hire of company vehicles since the last recession, not least because it provides known, easily budgeted costs with no hidden surprises. But what is contract hire exactly and how does it work?

What is contract hire?

It’s the most popular type of vehicle leasing in the UK, and allows the end user or lessee to hire a car for a set period of time and pre-determined mileage, in return for a fixed monthly contract hire rental.

How does contract hire work?

There is no option for the lessee to purchase the vehicle and, at the end of the contract, it is returned to the leasing company and reviewed for condition and mileage driven.

The monthly contract hire rental takes into account the cost of the car, including vehicle registration fees, road tax, its period of use and agreed mileage, funding costs and forecast residual value, which is the car’s estimated value at the end of the contract.

This part of the monthly charge is often referred to as the ‘finance’ element of the rental.

Is servicing included with contract hire rates?

The monthly rate for most contract hire agreements will also include a ‘service’ element, which can cover a range of additional services for an extra cost.

Examples of such services include all servicing and maintenance, replacement vehicles, roadside assistance, accident management and fuel cards.

Lessees are able to choose from a menu of options to meet their individual needs and the level of in-house fleet support required at an additional cost to the finance element of the contract.

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How is the cost of contract hire calculated?

Vehicle mileage is one of the most important factors in calculating the rental costs because the number of miles driven has major implications for both the vehicle’s service requirements and resale value.

Underestimating mileage can reduce the monthly rental rate for the lessee, but it can also result in excess charges at the end of the contract if contracted mileage is exceeded.

Typical contract mileages may be anything from 10,000-40,000 miles per annum, depending on usage and the company’s requirements.

The choice of vehicle model can also be a major factor. Two cars can have an almost identical list price, but if one has a much higher forecast residual value this will be reflected in a lower monthly rental rate. The car with the lower forecast residual value, on the other hand, will have correspondingly higher monthly rentals.

What do contract hire rates look like?

The minimum payment on a contract hire rental is normally three payments in advance. However, this can be as high as nine payments upfront depending on the contract and the customer’s credit risk.

sale and leaseback

Contract hire rates are normally calculated over a two, three, four or even five year periods. These are advertised as 3+23, 3+35, 3+47 or 3+59 contracts, with three payments in advance then the remainder over the rest of the term.

Contract hire rates, like most business expenses, are subject to VAT at the normal rate of 20%. If there is no private use of the vehicle, then 100% of the VAT can be reclaimed.

If there is private use of the vehicle, which is the most likely scenario, then 50% of the VAT on the finance element can be reclaimed.

If there is service and maintenance involved in the agreement, then 100% of the VAT on the service element may be reclaimed, provided these are separately identified and supplied.

What are the benefits of contract hire?

Commercial contract hire removes most of the risk of operating company cars and there is no risk to the lessee on the disposal of the vehicles, as this is borne by the contract hire and leasing company.

There is a known, fixed monthly cost which makes budgeting straightforward and does not represent a huge drain on cash flow which can be invested elsewhere in the business or used for other purposes such as acquisitions.

Cars on contract hire offer a number of other benefits including:

  • Off-balance sheet funding
  • Cash flow positive
  • VAT-efficient way of operating a company car
  • Fixed motoring costs for the contract period
  • Low risk as It removes the uncertainty surrounding future residual values
  • Reduced in-house administration freeing up staff time
  • Optional monthly maintenance charge covering routine maintenance and servicing cost

IFRS 16 leases: When contract hire is not ‘off-balance sheet’

A new lease accounting standard, IFRS 16 Leases, becomes mandatory from January 1, 2019, covering the future accounting treatment of leased assets, including those on contract hire.

The new IFRS lease accounting changes are intended to bring all leased assets on leases of more than 12 months’ duration onto a company’s balance sheet, giving a more complete picture of a business’s financial commitments.

This new approach will have different implications for different companies depending on factors such as size, profitability, attitude to risk and ownership of assets and a host of other issues. Talk to your contract hire company for more details.

Frequently asked questions

Is it a good idea to lease a new car?

Cars are historically one of the fastest depreciating commodities you can own, with huge amounts disappearing off their value the moment they are driven off the forecourt, which is why many question if it is better to buy or lease a car.

Contract hire and leasing helps negate loss of investment, with a fixed monthly cost taking into account any depreciation on the car. The more residual value a car keeps, the cheaper it is to contract hire. This is why many consider it a better option over an outright purchase.

Is insurance included in a contract hire deal?

No. The cost of insurance can vary wildly between companies and their drivers, and monthly contract hire rates rarely include insurance.

Is road tax included in a contract hire deal?

Yes, Vehicle Excise Duty or road tax will normally be included within the price of the arrangement.

Is servicing included in a contract hire rental?

You can choose car leasing with servicing included, although it can be optional.

If the contract hire deal does come with servicing included, the provider will pay for all servicing and scheduled maintenance, but some consumables such as tyres and windscreen wipers may not be included and charged as extra.

Is there a mileage limit on a contract hire deal?

Yes, all contract hire arrangements will have a mileage limit, and there will be an excess mileage charge for exceeding this. It is therefore important that you are realistic about the number of miles the vehicle will cover when you take out the lease. Selecting the appropriate mileages will save potentially expensive surcharges going forward, so opting for high mileage lease options from the very start may benefit you if you think you may exceed fixed limits.

Is it possible to amend the agreed mileage part-way through a contract?

Yes, most leasing companies will offer this facility, and some will pool the mileages of all the vehicles on the contract to cover any under and over-mileages. You may need to contact the contract hire company concerned to arrange an alternative agreement, as this may mean altering the monthly payments.

What if the car gets damaged during the contract hire period?

Minor damage such as lightly scuffed alloys and stone chips are unlikely to be an issue under the “fair wear and tear” clause found in most contract hire contracts, under guidelines issued by the British Vehicle Rental and Leasing Association. More severe damage will need to be fixed by an approved repair centre.

Is contract hire available to individuals as well as companies?

Yes, personal contract hire (PCH) has grown in popularity in recent years. It can be a valuable option for company employees who are given a cash allowance rather than being provided with a company car. PCH is a cost-effective and flexible form of funding which often works out cheaper than other forms of finance, such as personal contract purchase and hire purchase, because there is no option to purchase the vehicle at the end of the contract.

If you need more information about contract hire, please get in touch. At Maxxia we provide flexible vehicle funding options for business and personal use. Get in touch to find out what we can offer you today.

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