finance structures

Finance Structures

Tri-Partite Transactions

Debtor(Customer)

Creditor Supplier (Lender) (Dealer)

Tri-Partite transactions apply to:

o Hire Purchaseo Conditional Saleo Contract Hire (Operating Lease)o Finance Leaseo Lease Purchase

Balloon Payment

A Balloon Payment is a large payment that is made at the end of a finance agreement in order to have a legal right to ownership of the vehicle.

The payment relates to a large part of the value of a vehicle and this will result in lower monthly payments on the capital and on the interest

A Guaranteed Minimum Future Value (GMFV) is a balloon payment guaranteed by the finance company or manufacturer, and is based on the expected minimum value of the vehicle at the end of the agreement.

However, if this valuation is over-estimated then the customer is at risk of paying higher than the actual market value of the vehicle and may be left with negative equity.

1Finance Product Knowledge

The Dealer sends the completed financial proposal to the lender.

The Finance company (lender) accepts finance for the customer.

The Customer signs the finance documents.

The Dealer invoices the finance company the cost of the vehicle.

The Finance company buys the vehicle and the customer uses it.

The Customer completes documents including a vehicle

order form and finance proposal

The lender sells or hires the vehicle to the customer for an agreed period of time.

When all payments have been paid in accordance with a finance contract, the customer will have options available: Gain ownership to

the vehicle on a purchase plan, or …

Complete the contract on a lease and hand the vehicle back

Finance Structures

For example, if a customer has paid all monthly instalments during the existing agreement and decides to refinance for a new vehicle then the customer will need to settle the existing agreement by paying the GMFV of £5000 that was set at the beginning of the agreement.

However, to make the finance of the new agreement more affordable the customer will have to part-exchange the vehicle but is told that the current value of the vehicle is £4000 so the customer has negative equity of £1000.

Rentals/Payments

Standard Payment Profile

In January the customer has use of the vehicle after paying the deposit but the Agreement is ‘in arrears’ as the customer pays the first monthly instalment for January in the month of February.

Deposit Monthly Payments

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan

Advanced Payment Profile

Deposit and first payment received in January for the use of the vehicle in February. Comparing this to a Standard Payment Profile, we see that the Advance Payment Profile is one month less.

Deposit &1st Payment Monthly Payments

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Terminal Pause

A Terminal Pause is a period at the end of an agreement (usually lease) where no payments are required from the customer.

For example, a customer has a 12 month lease agreement with a profile of three advance rentals and nine monthly rentals resulting in a total of twelve rentals payments.

There is a Terminal Pause of 2 months as the rentals end in October.

3 AdvanceRentals Monthly Rentals

Terminal Pause



Finance Structures

Spread Rental

Spread Rental reflects a specific payment profile of a finance agreement. It is common in lease agreements as it uses the ‘Terminal Pause’ period of a finance agreement and allows payments during this time.

This helps to lower the cost of the monthly payments but the customer must pay in every month as there is no longer any ‘pause’.

Comparing to a Terminal Pause, a customer has a 12 month lease agreement with a profile of three advance rentals and eleven monthly rentals at a lower cost but this results in more rental payments of fourteen.

The rentals end in December as the Terminal Pause period is used to make payments.

3 AdvanceRentals Monthly Rentals (Spread)



Hire Purchase

Definition

Hire Purchase is a hiring agreement between a customer and a finance company secured against the vehicle, where the customer has the option to own the vehicle at some point during or after the agreement.

o One of the most common ways of funding a vehicle purchaseo Agreements are simply structured, normally up to a maximum of 5 years.o There are normally fixed costs and a fixed loan period of moneyo Tri-Partite Transactiono Regulated or Unregulated under CONC (Consumer Credit Sourcebook).

Deposit Fees Regular Option to Payments Purchase Fee

Ending the Agreement

A HP agreement can be settled at any time by the customer by paying the balance of finance outstanding and Option to Purchase fee to the lender.

The lender may allow the customer a rebate of the interest if the outstanding finance balance is settled before the agreement end date. If it is a HP agreement Regulated under CONC, then the minimum amount of rebate will be set out in the FCA’s rules.


A deposit is optional and is paid in cash or an old vehicle can be traded in as a part-exchange.

It Increases security the lender has in the vehicle and reduces the amount borrowed (and payments) by the customer.

There is usually an arrangement fee charged by the lender and any fees can be included as part of the regular repayments.

The fee amount is set by the individual lender.

A customer makes regular payments and should keep the vehicle fully insured and roadworthy.

There’s no mileage restriction but lenders may add restrictions on use and location of the vehicle.

The Option to Purchase fee transfers title to the customer.

It is usually paid by the customer with the final payment.

If the customer opts out of paying then the lender retains title to the vehicle.

Personal Contract Purchase

DefinitionA Personal Contract Purchase (PCP) is a purchase agreement where a loan is provided to purchase a vehicle and is based on a Hire Purchase or Conditional Sale contract. It differs from a HP agreement in that a PCP has a final balloon payment (GMFV) that is guaranteed by the manufacturer or finance company and the agreement will either be Regulated or Unregulated under CONC (Consumer Credit Sourcebook).

StructureThe repayments made by the customer are determined by: o The size of the deposito The mileage the customer expects to drive during the length of the agreemento The length of the term covered by the agreement, which is typically 3-5 years


A PCP agreement can be settled at any time by the customer if they pay the balance outstanding, including the GMFV to the lender.

The lender may allow the customer a rebate of the interest remaining on the agreement. However, if the agreement is regulated under CONC, the minimum amount of rebate is laid down by law.


The deposit is deducted from the price of the vehicle at the start of the agreement.

It is common for lenders to advertise very low levels of deposit to help attract customers.




Unlike HP, there are mileage restrictions and conditions of use still apply so the vehicle is worth the estimated value of the GMFV.

The Option to Purchase fee transfers title to the customer.

It is usually paid by the customer with the final payment.

If the customer opts out of paying then the lender retains title to the vehicle.

The GMFV is calculated after taking into account the term of the facility and the anticipated mileage.

At the end of the agreed term, the customer can keep, hand-back or part-exchange the vehicle.

Deposit Fees Regular Payments

Option to Purchase Fee

GMFV

£

Personal Contract Purchase

At the end of the PCP agreement the customer has three options:

Keep Hand-Back Part Exchange


The customer can pay the GMFV (and Option to Purchase fee) and legally own the vehicle.

The lender may allow the GMFV to be refinanced so the customer will avoid having to find a lot of cash.

If the vehicle is less than the GMFV, the customer can return the vehicle.

If the mileage limit has been exceeded then a charge of a pence per extra mile + VAT will apply and if the condition is worse than ‘fair wear and tear’, compensation must be paid from the customer.

If the dealers P/X value for the vehicle is greater than the GMFV, this sum (equity) can be used by the customer as a deposit towards financing another vehicle, or …..

The customer can sell privately, settle the GMFV by paying what’s left to the finance company and keep any profit.

Personal Loans

DefinitionA personal loan is an unsecured lending facility normally at a fixed cost and fixed term. The loan can be used to purchase any item the customer wants – including vehicles.

Unsecured loans are typically only used for borrowings under £25,000 and the exact amount will depend on the specific lender.

A personal loan is not a tri- partite transaction.

Debtor Creditor (Customer) (Lender)

No deposit involved as payments are made over a fixed term, normally a max of 5 years. The customer makes regular payments to the lender to cover the loan and interest. There are no mileage or usage restrictions on the vehicle that is financed. Regulated under CONC (Consumer Credit Sourcebook), unless one of the CCA

exemptions applies.

Fees Regular Payments


The customer applies for a loan from the finance company.

If approved, the customer uses the money to purchase the vehicle directly from the dealership and owns the vehicle from day one.

Finance companies do not usually loan more than £25,000, as the lending is unsecured and would pose a high commercial risk to the lender.

There is usually an arrangement fee charged by the lender and any fees can be included as part of the regular repayments. The fee amount is set by the individual lender.

Payments are usually made monthly in arrears, but `holiday` periods (e.g. 3 months of no payments) at certain times of the year are often advertised to attract customers.

Personal Loans


A personal loan agreement can be settled at any time by the customer by paying the balance outstanding to the lender.

The lender may allow the customer a rebate of the interest remaining on the agreement. If the loan is regulated under CONC, the minimum amount of rebate is set out in the FCA’s rules.

The agreement ends when all the contracted repayments have been made to the finance company. The customer already has title to the vehicle.


Contract Hire

DefinitionContract Hire (Operating Lease) is a method of funding the use of a vehicle for a set period of time (primary period of hire), but not the overall ownership of it.

It is available to any type of customer but because of its structure and form, it is ideally suited for VAT registered businesses and is Regulated and Unregulated under CONC.

Lessee(Customer)

Lessor Supplier (Lender) (Dealer)

Structure

Rental Set-Upo The customer covers the depreciation costs of the vehicle plus interest when making

rental payments during the term of the contract.o Depreciation costs take into account the anticipated mileage and condition of the

vehicle over time so the customer does not have to pay for the full cost of the vehicle!o The leasing company will have a residual value risk at the end of the term, which can be

thought of as something similar to that of a Balloon Payment/GMFV.

Residual Value RiskThe amount of the residual value risk (future vehicle value) is set by the lessor and the calculation is based upon a number of factors including the type of vehicle, the primary period of hire and the lessee’s anticipated mileage.


The Dealer sends the completed financial proposal to the lender.

The Finance company (lender) accepts finance for the customer.

The Customer signs the finance documents.

The Dealer invoices the finance company the cost of the vehicle.

The Finance company buys the vehicle and the customer uses it.

The lender hires the vehicle to the customer to use for a set period of time and within the anticipated mileage.

At the end of the period of hire, the customer gives the vehicle back to the leasing company.

The customer is not responsible for the disposal or sale price of the vehicle and the only risk to the lessee is any excess mileage or poor vehicle maintenance.

The Customer completes documents including a vehicle

order form and finance proposal

Contract Hire

VATo The customer pays less in rentals as the cost of the vehicle is based on the ex-VAT price

as the lessor can claim all of the VAT charged for vehicles used for business purposes.o Interest is added over a fixed period to the ex-VAT price of the vehicle and the amount

financed, less the residual value risk.o Rentals attract VAT but Contract hire is beneficial to businesses as they are able to

reclaim VAT if they are a VAT-Registered company.

Rental Paymentso There are no deposits involved.o It is normal for 3 Advance Rentals are paid at the start of the agreement.o All rentals will attract VAT.o The rentals during the remainder of the Primary Period of Hire will be spread equally

over the term or there may be a terminal pause.

Feeso Arrangement fees may be charged but it is less common than purchase agreements.

During an agreemento The lessee makes regular rentals to the lessor and must keep the vehicle fully insured.o Annual Vehicle Excise Duty (road tax) can be included in the rentals.o Service and maintenance plans are often incorporated into contract hire agreements.


The rentals are reflected in the notes to the accounts and will be a cost shown in the Profit and Loss Account of the lessee.

The vehicle only shows on the lessor`s Balance Sheet and it is not seen as an asset or liability on the lessee’s Balance Sheet.

If the lessee is VAT registered, the VAT on the rentals can be wholly or partially reclaimed by the lessee:

Commercial vehicle – all of the VAT on the rentals can be reclaimed.

Car – all of the VAT on rentals can be reclaimed if the car is 100% for business use or 50% if there is any private use.

Contract Hire

End of agreement

End of Contracto At the end of the primary period of hire, the lessee will return the vehicle to

the lessor.o If the vehicle has exceeded the agreed mileage then a pence per mile charge

plus VAT will apply to each mile over the contracted amount. This calculation is based on the type of vehicle, agreed mileage and the maintenance costs.

o If the condition of the vehicle is worse than `fair wear and tear`, the lessor is allowed to charge the lessee to compensate for the poor condition.

Early Settlemento The contract hire agreement can be settled at any point but the penalties for

doing so are often high and will be detailed by the lessor in the agreement.

Extensionso The lessor may allow the lessee to extend the length of the contract past the

Primary Period of Hire, though there may be a change in the rental amounts for this additional period.

Personal Contract Hire

As a lessor is able to reclaim the input VAT on the purchase of the vehicle it means that

the interest is added to the ex-VAT price of the vehicle and results in lower payments

than traditional finance agreements.

A private individual may then be tempted to take out a Personal Contract Hire

agreement but it must be noted that all personal contract hire rentals attract VAT and

private individuals will not be able to recover this as they will not be VAT-registered.

The structure, terms and conditions of personal contract hire are the same as normal

contract hire.


Conditional Sale

Definition

The key difference between Conditional Sale and Hire Purchase is that the customer is obliged to buy the vehicle outright at the end of the agreement. There is no Option to Purchase Fee to be paid, as there is with Hire Purchase.

o Key difference is the customer committing to being the legal owner of the vehicle.o Fixed interest rate and fixed period of repayments.o Balloon payments are also used under Conditional Sale agreements but not HP.o Tri-Partite Transaction.o Regulated or Unregulated under CONC (Consumer Credit Sourcebook).

Deposit Fees Regular Balloon Payments Payment


The agreement can be settled at any time by the customer by paying the total balance outstanding to the lender.

The lender may allow the customer a rebate of the unused interest, however if it is a regulated agreement under CONC, the minimum amount of rebate is laid down by law.

At the end of a Conditional Sale agreement, once all repayments have been made, title to the vehicle passes to the customer.


A deposit is optional and is paid in cash or an old vehicle can be traded in as a part-exchange.

It Increases security the lender has in the vehicle and reduces the amount borrowed (and payments) by the customer.




There’s no mileage restriction but lenders may add restrictions on use and location of the vehicle.

A balloon payment in the agreement is possible but this is uncommon as the customer is already committed to purchasing the vehicle, whereas balloon payments, e.g. in PCP, are for customers wanting to lower their risk in spending.

Credit Sale

Definition

A Credit Sale agreement is a purchase agreement where title to the goods passes immediately to the customer as it involves low value items where recovery of the vehicle would be impractical.It has a structure similar to a Hire Purchase agreement. However, a Credit Sale is an unsecured finance agreement which is not directly secured to a vehicle.

o Agreement is normally a fixed cost, fixed term loan.o Tri-Partite Transaction.o Regulated or Unregulated under CONC (Consumer Credit Sourcebook).



The agreement can be settled at any time by the customer by paying the balance outstanding to the lender.

The lender may allow the customer a rebate of the unused interest, however if it is a regulated agreement under CONC, the minimum amount of rebate is laid down by law.

The customer will already have title to the vehicle under a Credit Sale agreement.


A deposit/advance rental(s) is optional and is paid in cash or an old vehicle can be traded in as a part-exchange.

It Increases security the lender has in the vehicle and reduces the amount borrowed by the customer.



A customer makes regular payments and there are no usage or mileage restrictions.

Termination and repossession rights do not apply as the title is immediately transferred to the customer.

A balloon payment in the agreement is possible but this is uncommon as the vehicle is of a lower value and lower risk to that of a vehicle on another plan, for example, a PCP.

Lease Purchase

Definition

A Lease Purchase is purchase agreement similar to a Hire Purchase or Conditional Sale agreement except that payments are structured like a lease agreement where the customer pays advance payments rather than a deposit.

o As it is a purchase plan, the payments do not attract VAT. o The customer can take title/ownership of the vehicle at the end of the agreement.o Tri-Partite Transaction.o Regulated or Unregulated under CONC (Consumer Credit Sourcebook).



An agreement can be settled at any time by the customer by paying the finance outstanding (and the Option to Purchase fee, if required) to the lender.

The lender may allow the customer a rebate of the interest that has been avoided by paying early, if the agreement is regulated under CONC.

At the end of a contract, once all the contracted payments have been made (plus the Option to Purchase fee) the customer has legal title to the vehicle and becomes its legal owner.


A deposit and/or advance payment is optional and is paid in cash or an old vehicle can be traded in as a P/X.

It Increases security the lender has in the vehicle and reduces the amount borrowed by the customer.

There is usually an arrangement fee charged by the lender.

The fee amount is set by the individual lender (plus an Option to Purchase fee at the end of the agreement if it is based on a Hire Purchase contract).

A customer makes regular payments.

Restrictions on mileage don’t apply but might on usage.

Title to the vehicle passes to the customer once all payments (and any Option to Purchase fee) have been paid.

A balloon payment at the end of a Lease Purchase may also be included.

If a Lease Purchase contract is based on a Conditional Sale agreement then there is no Option to Purchase Fee to be paid.

Finance Lease

DefinitionFinance Lease is a method of funding the use of a vehicle for a set period of time (primary period of hire), but not the overall ownership of it.

The customer rents the vehicle and either sells it on behalf of the lessor at the agreement end or enters into a secondary period of hire.

A Finance Lease transfers the majority of the risks and rewards of ownership to the lessee/customer.

StructureFinance Lease follows a similar structure as Contract Hire, as seen on page 9.

Finance Lease versus Contract Hire There are two main differences between a Finance Lease and a Contract Hire (Operating Lease) agreement:

Balloon Payment

Balance Sheet

• Ending the Agreement

A Finance Lease can be settled at any point during the term (although sometimes only after the first 12 months).

However, penalties for doing so can often be high and will be detailed by the lessor in the terms and conditions of the agreement.

At the end of the primary period of the agreement, the customer must have fully paid all the rentals, including any balloon. The customer then has three options:


A Finance Lease can be structured with or without a balloon payment. However, a Contract Hire agreement always takes into account a residual value set by the leasing company, but this is not visible to the customer nor is it their responsibility.

The vehicle on a Finance Lease agreement is shown in the Balance Sheet of both the lessor and lessee as a leased asset. Under Contract Hire, it is only the lessor (Lease Company) who lists the vehicle on their Balance Sheet.

Finance Lease

Return the vehicle

Lessee arranges sales as an agent

Continue to use


The vehicle is returned to the Lessor, who will sell it and refund any surplus sale proceeds to the customer as a rebate of rentals (around 95% of the surplus sale proceeds with some of the surplus being retained by the Lessor to cover administration costs).

If the value of the vehicle is in negative equity (only likely to happen if there is a balloon) then the Lessee is liable for any shortfall.

The Lessee acts as an agent of the Lessor and arranges the sale of the vehicle to an `independent third party`. The Lessor receives the full sale proceeds and refunds the Lessee a fixed percentage (as above) of any surplus that is generated as a rebate of rentals.

The Lessee continues to use the vehicle for as long as they want on an annual secondary period rental (peppercorn rental). This is normally the equivalent of one monthly rental but this option is not normally available where there is a balloon rental payable.

Secured Loans

DefinitionA secured loan is a finance agreement that is secured against a tangible asset or land, regardless of what the loan will be used to purchase.

Secured loans are typically used for borrowings over £25,000 and the exact amount will depend on the specific lender.

A personal loan is not a tri- partite transaction.

Debtor Creditor (Customer) (Lender)

Payments are structured over a longer period of time than an unsecured loan, typically ranging from 5 – 30 years.

The loan is normally linked to the amount of equity in a customer’s house. No deposit involved and the customer makes regular payments to the lender to cover

the loan and interest. The agreement is Regulated under CONC. However, loans secured against a mortgage

are not regulated under the CCA.

Fees Regular Payments


The customer applies for a loan from the finance company.

If approved, the customer uses the money to purchase the vehicle directly from the dealership and owns the vehicle from day one.

The lender ‘secures’ the loan against the debtor’s tangible assets or land and this reduces the risk in providing finance to the debtor.

The loan is usually secured against a mortgage or another value or asset.

Lenders usually charge fees for providing a secured loan and these will be disclosed to the customer before signing any agreement, and it is usual to have a fee at the start of the agreement and a valuation fee to estimate the value of the property. Fees are usually added to the loan or are paid up front by the debtor.

Payments usually determined on equity in the customer’s property.

No mileage or usage restrictions apply as the customer legally owns the vehicle.

Payments are based on a variable rate of interest .The rate of interest may well be linked to the Bank of England Base Rate.

Secured Loans

Ending the AgreementA secured loan agreement can be settled at any time by the customer by paying the balance outstanding to the lender. The lender may allow the customer a rebate of the interest that has been avoided by paying early.

If the agreement is Regulated under CONC. However, secured loans (where a mortgage) are not regulated under the CCA.

The agreement ends when all the contracted payments have been made.


Interest Rates

Definition

Fixed Interest RateA fixed (flat) rate of interest is an interest calculation based on the amount of money borrowed and the period of the loan and will not change during the life of the agreement.

Annual Interest

Fixed Interest Repayments

Payment Structure

JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DECAlthough the customer payment remains the same for the term of the loan, the actual amount of capital repaid in each payment will get larger and the interest element will get smaller as the agreement reaches the end of its term.

Definition


The fixed interest rate is calculated on an annual basis and does not take into account any reduction in the capital amount when the customer makes monthly payments.

The fixed rate of interest applies to the capital amount borrowed only (unlike Annual Percentage Rate (APR) which reflects all interest and fees/charges paid by the customer).

%

The fixed interest rate is calculated on the total amount borrowed and will not change during the life of the agreement.

Regular payments that the customer makes to the finance company will remain the same throughout the term of the agreement.

MONTHLY PAYMENTS

FIXED INTEREST PAYMENTS AT 10%

2014

Interest Rates

Variable Interest RateA variable rate of interest is an interest rate on a loan or security that changes over time in line with current market conditions. For example, mortgage agreements ‘track’ the Bank of England base rate which will change over time.

Rise in interest rates = Higher monthly repayments Fall in interest rates = Lower monthly repayments

Components

Finance House Base Rate

Margin

Payment Structure

JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DECThe amount of capital being repaid with each payment will be the same amount with each repayment.However, the amount of interest charged within each repayment will fluctuate to reflect the reducing balance of capital outstanding and the prevailing interest rates.


VARIABLE INTEREST PAYMENTS

MONTHLY PAYMENTS

This is the underlying base rate that reflects the cost for lenders of borrowing money from the marketplace.

The FHBR will fluctuate depending on market conditions. The Finance House Base Rate is calculated each month by the Finance & Leasing Association (FLA).

Lenders will also include a fixed amount of margin to cover all the known costs to the lender, such as overheads and wages, which is added to the profit and commission margin.

For example, FHBR (2%) + Margin (4.5%) = Total Annual Interest (6.5%).

finance structures

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