Does it make sense to rent your car?

Couple buying cars © iStock
Do the sums before you sign

Leasing can seem a good way to get a new car more cheaply and flexibly than buying one. In return for a fixed monthly payment, you get to use the car for a few years, return it at the end of the lease and perhaps replace it with another brand new vehicle. However, if you’re tempted, it’s important to consider whether an arrangement under which you never own your car is really the best option.

There are two main types of car leasing agreement: personal contract hire (PCH) and personal contract purchase (PCP). If you sign up for a PCP agreement, you’ll pay a deposit and then monthly payments. At the end of the term, you’ll have the option to buy the vehicle for an extra payment. With a PCH deal, you usually pay three, six or nine months’ rental in advance, followed by monthly payments for the remainder of the lease – normally two, three or four years. You never own the vehicle and at the end of the term you either hand it back or take out a new lease. PCH is the most common form of car leasing and generally involves lower monthly payments than PCP.

The key selling point of a PCH agreement is that you don’t have to worry about the car’s depreciating value – that’s the finance company’s problem. “It might seem counter-intuitive that, for some motorists, leasing a car might work out cheaper than buying one – after all, if you buy a car, you’ll own an asset once any finance on it is paid off,” says Matt Sanders, of GoCompare Money, a comparison website. However, “all but the most prestigious cars are a depreciating asset, and some cars depreciate faster and further than others, particularly if you rack up high mileage”.

PCH deals can therefore be a good option for makes and models that depreciate quickly. However, for cars that are slower to depreciate, a careful, low-mileage owner might get better value by buying instead. “Just be aware that leasing companies will be experts in car value and depreciation and may factor the costs of greater depreciation into a particular model’s lease fees or deposit.”

How many miles you plan to drive each year is another key factor when deciding whether to lease a car, and finding the right lease agreement. To determine your payments, the company will deduct the estimated “residual value” from the retail price of the car, leaving you to pay the difference in monthly instalments. Importantly, the residual value of the vehicle – its value at the end of the contractual period – largely depends on how many miles it’s done.

So, in general, the fewer miles you plan to do, the cheaper your lease will be. Take, for example, a Nissan Juke diesel hatchback 1.5dCi N-Connecta leased from Select Car Leasing. A three-year deal based on annual mileage of 5,000 miles will cost £141.59 a month, but a 10,000-mile limit sees the payment jump to £163.19 a month. If you exceed your annual mileage, there will normally be a penalty to pay based on how many extra miles you have driven.

Finally, it’s important to factor all costs into your decision. Some PCH deals also include road tax and an annual service. If these costs are not included, you need to budget for these and for the cost of insurance. “Because vehicle leasing is a form of credit, leasing companies will carry out a credit check to make sure you can afford the deal,” says Sanders. “Some companies specialise in providing lease vehicles to those with adverse credit histories, but be aware that leasing a vehicle is likely to be more expensive for these customers. Customers in such a situation may want to consider other options, such as saving up to buy a vehicle outright instead.” Finally, as with other rental contracts, be aware that failing to keep up with your repayments could see your lease vehicle repossessed.

Is a new subprime crisis on the horizon?

A sharp increase in the amount being borrowed to buy new cars in the UK and the US is raising concerns that a collapse in the sector could bring about another bad-debt crisis. In the UK, the Bank of England has warned that consumer credit, including car loans, was close to levels not seen since the 2008 financial crash, says Patrick Collinson in The Guardian. A record £31.6bn was borrowed in the UK last year for the purposes of buying a new car, according to figures from the Finance and Leasing Association, up 12% on the year before. Car leasing is even more common in the US, where car loan debt hit $1.16trn at the end of 2016, a $93bn rise over the year, according to the Federal Reserve Bank of New York.

However, there is growing concern that too many people are struggling to repay these loans. In the US, car-loan payments that were behind by 30 days or more grew to $23.27bn in the fourth quarter of 2016, the highest level since the third quarter of 2008. A third of US car loans are now classified as “deep subprime”, says Matt Scully on Bloomberg.com, meaning the borrowers who took out the loans have very low credit ratings.

Finance companies usually value the vehicles against which the leases are issued conservatively, so it should take “a big drop in used car prices to cause serious problems”, says Jonathan Eley in the Financial Times. If that occurred, it would hit the carmakers’ leasing divisions first. “The Bank of England reckons they finance 70% of new car leases in the UK, and they are vast businesses. Globally, Volkswagen’s financing arm alone has €157bn of loans to customers on its books.”

Car loans are commonly parcelled up into “asset-backed securities”, which can be sold on to investors, such as pension funds, that are looking for income. Wall Street banks have become increasingly willing to underwrite these asset-backed securities in recent years, after new regulations brought in after the financial crisis made other areas of business less profitable. Hence they could also be on the hook if bad debts start to rise – although car loans are “not a big enough asset class to cause problems for the financial system as a whole”, Steve Eisman, the hedge fund manager who made his reputation betting against sub-prime mortgages, tells Bloomberg.