► Contract hire

At a glance

Contract hire is the most popular method of funding and oils the wheels of the fleet industry.

It attracts many fleets because it offers the vehicle of choice for a fixed monthly payment over a fixed period.

Many fleet decision-makers like it because it offers a clear benchmark between competitors, and can nearly always be done quickly and easily on the internet.

Contracts run for between two and four years, with the industry benchmark set at three years/60,000 miles.

These are drawn up so the contract hire firm is likely to get what they planned for the car when they sell it on – part of the equation that makes contract hire viable.

The leasing firm has already decided what the future residual value of the car will be, what the maintenance costs will be and what it needs to charge for profit, which it sets down in the leasing rate.

Some fleets have an open agreement with their leasing provider stating that although the contract hire firm will bear all residual value losses, where their cars achieve more than expected at disposal, the amount will be shared equally between supplier and fleet.

The same can be agreed on maintenance, but because of the amount of paperwork involved, in both cases the settlement tends to be an end of year process.

Strengths

There's very little risk for the fleet because the monthly rental rate is unaffected by any sudden changes in the used car market.

The rate you pay the leasing company is set for the life of the deal.

To ensure costs remain the same, the fleet customer must ensure the vehicle is in an acceptable condition for its age and mileage and hasn’t gone over mileage limits set at the start of the term.

You can include maintenance in the deal, or opt to pay for any work in the garage yourself, taking into account the leasing company takes the risk of any unexpected costs rather than the fleet if you include it in the lease.

One of the distinct advantages contract hire has over some of its funding counterparts, such as hire purchase, is its current tax efficiency.

VAT-registered companies are able to reclaim 50% on the finance of the car, and 100% on service.

Hire companies are also able to claim 100% on the cost of the cars, as they are used solely for business purposes, which in turn can be represented in lower rental costs for the fleet operator.

Another advantage of contract hire is that the vehicles do not appear on the fleet’s balance sheet.

This means a company does not have a depreciating asset on its books that it has to write down in value every year – a costly exercise for large fleets.

Instead, the off-balance sheet approach allows a company to just register the cost of the monthly lease.

Contract hire suppliers are experts in providing additional services to fleets, so in your monthly leases, you can specify breakdown cover, accident management, driver support and GAP insurance.

Some leasing firms write off small bills and scrap tyre damage recharges to make the service simpler.

Weaknesses

The major problem with contract hire is end-of-contract charges – mainly for wear and tear and excess mileage.

These can really mount up if a fleet does not keep control of what drivers are doing with their vehicles

Extra charges are incurred to reflect the reduced value of the vehicle for having a higher mileage or being in worse condition than expected, and the bills can run into thousands of pounds if not managed.

Companies offering contract hire depend on the vehicle being worth what they expect at resale time and if it is not, they will pile on the charges to counteract this shortfall.

There is opportunity to rewrite contracts if you believe cars are going to go over their mileage limits during their working life, but be careful because the contract hire firm is very much in the driving seat and you could end up paying a much higher rate.

One way to avoid these charges is by asking for any vehicles with higher mileages to be offset against vehicles with lower mileages to achieve a rough average, called pooling mileage.

For example, if a firm had two vehicles on a contract hire agreement for 60,000 miles and one came back with 70,000, while another had 50,000, the pooled mileage would hit the 60,000 benchmark.

There is also very little opportunity for fleets to benefit from unexpected windfalls, such as higher than expected disposal prices, because prices are set in stone.