There are so many options to choose from when financing your vehicle. And one of the more flexible options of the lot is contract purchase.
Contract purchase is primarily for businesses. There is a contract purchase for private individuals, aptly named Personal Contract Purchase.
So, what is contract purchase? In this article we’ll be looking at what contract purchase is, its pros and cons, and whether it’s right for you.
What is contract purchase?
A contract purchase, or CP, is essentially where a company pays monthly payments for a set period of time. At the end of the agreement, you have three options;
- Part exchange the car and use the equity towards a deposit for your next car
- Buy the car for a pre-agreed amount
- Hand the car back (subject to mileage and condition restrictions)
So, there’s quite a bit of flexibility with the contract.
What are the pros of contract purchase?
Some of the advantages of CP are;
- You have the option to buy at the end
- This is an attractive benefit for many
- The price is pre-agreed at the beginning of the contract
- This means that should you decide to buy the car, you can budget accordingly.
- The monthly payments are affordable
- Due to the balloon payment at the end, the monthly payments are lower
- The car can be depreciated into the business accounts
- This enables tax efficiencies
- The company can offset the financial interest charges against corporation tax
- The vehicle is an asset to the business
- This may help towards a company’s balance sheet.
- If you choose to sell the car on – anything you make above the balloon payment is yours to keep
- You don’t have to decide what you want to do straight away
- Normally, you don’t have to make a decision until the month before it ends.
What are the cons of contract purchase?
However, nothing comes without its disadvantages. Some of the things you should take into consideration when looking at this option are;
- The monthly payments tend to be higher than on a contract hire
- In some cases, the interest rate is slightly higher than a hire purchase
- You are responsible for taxing the car every year
- The whole cost of the vehicle is shown on your credit file
- This could affect your credit score
- You’re still subject to mileage and condition restrictions
- Especially if you’re planning to hand the car back
Who is Contract Purchase for?
Contract purchase is perfect for those who;
- Want the option to buy the car at the end of the contract
- Will have their car paid for by the business
- Want the option to hand the car back at the end
How is the cost of a contract purchase calculated?
The cost this is determined by a number of things. Namely, what you decide to do at the end.
At the start of your contract you will set a balloon payment. This is essentially how much the car should be worth at the end. This is also known as the minimum guaranteed future value (MGFV).
This balloon payment is then deducted from the cost of the car. However, the expected depreciation of the car is added. This is based on how many miles you are doing. This total amount is split into the amount of months you have the car for.
The overall cost of the monthly payments are determined by;
The cost of the vehicle
- Length of the contract
- The residual value
- Any additional extras such as maintenance packages (more on that below)
What other things should I consider when looking at Contract Purchase?
When looking at this option, there are some things you should also think about. These include;
- Company car tax
- GAP Insurance
- Maintenance package
What is company car tax?
If you are using your car for personal use, then you will have to pay company car tax. Personal use does include travelling to and from work.
You don’t have to pay company car tax, however, if you are;
- A partner or a partnership
- A member of a limited liability partnership (LLP)
- The proprietor of your own business
Unfortunately, if you are a director of a limited company, you still have to pay company car tax.
The amount of company car tax you will have to pay is determined by the type of car and the P11d value. How much you pay a month is determined by your income, and what tax bracket you are in.
You can read our comprehensive guide to company car tax here.
What is GAP insurance?
GAP insurance, otherwise known as guaranteed asset protection insurance, is another thing you may want to look at.
In the unlikely event of a write off due to theft, fire or an accident, GAP insurance will cover the difference between what the insurance company pays out, and what the finance company will want to cover their loss.
So, GAP insurance prevents you from being in a negative equity situation.
What is a maintenance package?
If you are handing your car back, then you need to keep it maintained. Of course, even if you aren’t then you still want to maintain it to keep it in the best condition possible. This is an additional cost that you have to take into consideration when thinking about your budget.
However, you can spread that extra cost over monthly payments with a maintenance agreement. A maintenance agreement covers the servicing costs for the entirety of your lease contract. There are a few extras thrown in as well. The cost of this will depend on the length of your contract and your annual mileage.
For more information on what a maintenance agreement contains, read our article here.
Hopefully this has cleared a few things up about contract purchase. It’s perfect for businesses who want the option to own at the end. It’s more flexible than the other agreements. But, you do still have to take into the mileage and condition restrictions should you decide to hand the car back.
- Benefits of business car leasing - 13th April 2021
- Things businesses should consider before hiring a Fleet Manager - 12th April 2021
- Tax benefits and implications of business car leasing - 8th April 2021