Leasing a car vs financing
The vehicle leasing industry is growing. The British Vehicle Rental and Leasing Association recently reported a 0.65% increase year on year with car fleets up by 4.9%. Meanwhile, new car registrations have increased year on year by 12.4%.
If you’re wondering whether you should lease or finance your new or used company vehicle (or fleet of vehicles), read on. We’re covering the differences between each, including pros and cons, and tax implications.
Leasing vs financing a car: comparing the features of each
Leasing and financing company cars are both great options for businesses looking to preserve cash flow. Here’s how the two options match up against each other.
Mileage restrictions
Both financing and leasing agreements can come with mileage limits, however, restrictions are much more common with leasing agreements.
Ownership
At the end of the term, you take on ownership of the vehicle with a financing agreement. With a lease, you return the vehicle, extend the lease, or trade in the car for a new one.
Cost
Comparing costs is a tricky one, as the two financing types function differently. If you’re wondering about monthly costs, a lease is generally cheaper. This is because you’re only paying for the cost depreciation as well as the company’s profits.
However, if you’re thinking about long-term costs, that’s when things can get a bit more complicated. The monthly cost of a lease is smaller than the monthly repayment fees of a financing agreement. But at the end of a financing agreement, you get ownership. This gives you an asset you can trade in for a new vehicle, sell for working capital, or hold onto without the need to pay a monthly fee for the car.
Flexibility
Once a lease term has ended, many lenders offer you the ability to return the vehicle, trade it in for a new one on a new lease, or extend the lease. With financing, you can usually pay a termination fee, which will enable you to sell the car and purchase, lease, or finance a new one. Alternatively, once the finance term is complete, ownership transfers to you and you’re free to sell the car or trade it in for a different one with a dealer at your leisure.
Modification
It’s much harder to modify a company vehicle under a leasing agreement. If this is a concern for you, you might want to consider buying or financing the vehicle.
Is it better to lease or finance a car for your business?
Working capital
Whether a lease or finance agreement is better for your business depends heavily on your personal circumstances. One area to consider is your working capital. The lower monthly payments associated with a lease can be better for cash flow. However, owning the vehicle at the end of the finance term can give you an asset to leverage as collateral for future financing.
Usage and scalability
How you intend to use the vehicle has an impact on whether a lease or finance agreement is better for your business. If you plan on scaling up your mileage usage, a financing agreement may be better. However, if you foresee a future where you’ll want to upgrade to more or better vehicles, a lease might offer the flexibility you need.
Long-term needs
If you think this vehicle will maintain its value long-term and you intend to use it for the foreseeable future, a financing agreement might give you the long-term stability you need. A lease is generally seen as more of a short-term option.
Maintenance responsibilities
Do you want to be responsible for the maintenance of the vehicle? A financing agreement puts you directly in the driving seat of your vehicle’s need for repairs and maintenance. Some leasing agreements take on maintenance obligations on their end.
High-mileage service firm
As an example of how your unique circumstances impact which option is best for you, if you work in deliveries or another high-mileage services business, financing may be more appropriate. Leasing often comes with mileage limits and damage liabilities.
Cash-tight startup
Running a cash-tight startup often involves limiting your monthly outgoings as you build up the business to a point where it's profitable and stable. For this reason, a lease would be a better option. Leases are cheaper in the short-term, creating less of a strain on working capital. Also, a lease may be easier to gain access to if your business has a limited trading history and fewer assets.
Growth-stage fleet
Both leasing and financing have some great positives for businesses in this situation, as well as drawbacks. With leasing, you could scale your fleet quickly, adding on new vehicles as you grow. For example, you could enhance your fleet with a Range Rover business lease.
However, with financing, you establish a long-term base of assets which you can draw on for future capital. A good solution might be to finance a few vehicles while leasing others. This means you can quickly add new vehicles to your fleet by leasing them, and then finance them later when they are worth it.
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What does leasing a car mean?
Rental agreement
A lease is a type of rental agreement in which you borrow the vehicle in exchange for regular repayments.
Short-term
Many leases are short-term in nature, spanning around 2-3 years, at which point you may either return the vehicle or extend the term.
Usage limits
With a lease, you pay for depreciation, but the finance company still owns the vehicle. To protect their investment, finance companies often implement usage limits, which limit your annual mileage as well as any potential modifications to the vehicle.
Learn more about financing and leasing a car
How does leasing work?
Deciding between leasing and financing company assets can be hard – understanding how each one works can help. With leasing, you first find a vehicle to use, this can usually be done through the leasing company themselves, who may have a range of vehicles on their website.
Once you’ve found the vehicle (or fleet of vehicles) you want to borrow, you agree to a regular monthly payment, a mileage limit, and the lease term. The leasing provider will usually take the monthly payment directly from your bank account, but some work differently, so be sure you understand exactly how your payments will be taken before entering into an agreement.
At the end of the lease, you may be charged for any damages that exceed fair wear and tear, or for any usage that extends over the mileage limit. You'll usually have the option to either extend the lease, return the vehicle, or take out a new lease on a new vehicle.
How does financing work?
In the case of financing, you're essentially taking out a loan to purchase the vehicle, and then repaying the loan. You may be asked for a deposit, which may be paid directly to the dealer, rather than the financing provider, but not always.
The lender will agree loan amounts, interest rates, and the loan term with you. Bear in mind that company loan rates are not always set in stone and it’s important to budget for potential changes to your monthly repayment amount, particularly if you take out a variable rate loan.
Over the course of the loan term, you repay the loan amount plus interest and fees, until the vehicle is completely paid off. If you used, for example, truck finance, you would, at that point, own the truck.
Understanding tax implications
There are several tax implications of both business vehicle leasing and financing vehicles. Here are some of the factors to be aware of.
VAT reclaim
The general rule of thumb is that you can claim back 50% of the VAT payment for a leased commercial vehicle. This amount can vary based on circumstances.
Capital allowances
Business vehicles do count towards capital allowances as long as they are used for a business purpose. This means you can include the payments you make to lease or buy a company vehicle on your balance sheet, potentially deducting the total amount from your profits for the year, possibly lowering your total tax liability.
What is HMRC's VAT Notice 700/64?
This details how to calculate VAT and fuel and submit that information to HMRC with regards to motoring expenses for businesses.
Pros of leasing a car
There are several reasons businesses choose to lease over financing. Here are a few of the benefits.
Working capital
Leasing often reduces both the need for a large upfront payment and the strain of large monthly payments. Since you’re only paying to rent the vehicle, rather than spreading the cost of a purchase, commercial vehicle leases are often cheaper on a monthly basis, which can be a big help for working capital.
Easy upgrades
Once the lease term is over, you usually have the option to upgrade to a newer model with a new lease. This flexibility and modernity can be appealing to some business owners.
Drawbacks of leasing a car
While there are many advantages to leasing a vehicle, there are also drawbacks. For starters, you never own the vehicle, so you are either stuck in an eternal loop of paying for vehicles, or, you will one day need to purchase a vehicle. The mileage and modification restrictions can be tough for some business types, and if you damage the vehicle you may have to pay the provider a fee.
Pros of financing a car
There are also plenty of reasons businesses choose to finance a vehicle over leasing, including some of the following benefits.
Ownership
Ownership can mean one day no longer needing to make regular payments towards a vehicle – for instance, van finance can help you work towards owning a van. Ownership can also mean you have an asset which you could sell if you need working capital, or you can use it as security for a loan to gain funding.
Long-term financial strategy
Ownership can turn out to be cheaper in the long run, particularly if you intend to use the vehicle for a long time or if you run over mileage limits. An example of one such vehicle is trucks – it can be expensive to buy a truck, but truck finance can help you purchase it if your business is in need.
Drawbacks of financing a car
Some of the drawbacks of financing a company vehicle include the possibility of needing to make a large upfront payment in the form of a deposit, the monthly costs being higher as you work towards ownership, and the risk of depreciation.
Lease vs financing a car cost
Monthly payments with a lease are lower than those involved with a finance agreement, as you’re not paying off the value of the car. However, leases can be more expensive long-term since the cycle never ends, you must continue leasing new cars or eventually turn to ownership. With ownership, once the loan is paid off, you can drive payment free.
Many leases cover maintenance and repair costs, which finance agreements do not. But, you can get charged for over-usage of mileage with a lease. There is often a deposit involved with a finance agreement, which leases do usually include too, but often at a lower amount.
Is it cheaper to lease a car long-term?
It depends on how long you mean by long-term, however, in general, the answer is no, it’s not cheaper to lease a car over buying one in the long-term. This is because when you lease the vehicle you never gain ownership, so you’re always paying towards the leasing company. When you purchase a car, or spread the cost with hire purchase, the payments eventually stop and the car becomes an asset.
More FAQs
Understanding the cost of ownership
Ownership comes with many great benefits, but it's also a responsibility that comes with its own costs. This includes the cost of servicing and maintaining the vehicle. There's also the cost of depreciation (ie the car’s value declining as it ages) to be considered, as well as the cost of managing a sale or trading of the vehicle later in time.
What is the most cost-effective way to own a company vehicle?
That depends on if you mean cost-effective in the short-term or in the long-term. If your ultimate goal is ownership so that you no longer have to pay regular fees towards your vehicles, then hire purchase or buying outright is more cost effective. If you want to pay a smaller amount each month because you need less outgoings on your balance sheet, leasing a vehicle may be more cost-effective.
Do you pay interest on a leased vehicle?
No, instead of interest on a loan, you usually pay for the cost of depreciation plus the provider’s fees. Interest is charged on a loan, whereas a lease is more like a rental fee.
What happens at the end of a finance lease?
At the end of the finance lease, you'll usually have the option to return the vehicle to the provider, extend the lease, or lease a new vehicle.
Is it better to lease or buy a car in the UK?
Whether it’s better to buy or lease a car in the UK is down to each business' individual circumstances. As an example to highlight which might be better, let’s consider an established agricultural business looking to use a car to drive to and from town. They predict the car will continue working well for the next 20 years, and they plan to need it for this length of time. The business does have a regular stream of income, and after budgeting, the farm owner knows they can afford a large amount per month. In this case, financing the vehicle would be better.
On the other hand, let’s imagine a newer business with a less stable monthly flow of cash into the business, looking for a car to use for the next 2 years to drive to and from business meetings as they grow their cash flow with new revenue. In this case, a lease may be more suitable.
Can you lease a second-hand car?
Yes, leases are often available for second-hand vehicles. It all depends on the provider and the vehicles they have available.
Is insurance included in a car lease?
Insurance isn't usually included in a business car lease. You are often required by the law and by the leasing company to get insurance on any leased vehicles.
Please note that the information above is not intended to be financial advice. You should seek independent financial advice before making any decisions about your financial future.
It’s important to remember that all loans and credit agreements come with risks. These risks include non-payment and late-payment of the agreed repayment plan, which could affect your business credit score and impact your ability to find future funding. Always read the terms and conditions of every loan or credit agreement before you proceed. Contact us for support if you ever face difficulties making your repayments.
Funding Options, now part of Tide, helps UK firms access business finance, working directly with businesses and their trusted advisors. Funding Options are a credit broker and do not provide loans directly. All finance and quotes are subject to status and income. Applicants must be aged 18 and over and terms and conditions apply. Guarantees and Indemnities may be required. Funding Options can introduce applicants to a number of providers based on the applicants' circumstances and creditworthiness. Funding Options will receive a commission or finder’s fee for effecting such finance introductions.
Joe Morley
Head of Unsecured Lending
Joe has worked in the alternative lending space since 2015. During this time he has helped hundreds of SMEs access millions in essential funding ranging from long-term asset-backed lending to short-term unsecured revolving credit lines and beyond. In his role, Joe manages and supports a large team of Credit Finance specialists.