How Cars Are Financed

Leasing companies, no matter how big or small need to raise capital in order to finance vehicles. One way in which they do this is to have an agreement with their bank and/or lender, and it fundamentally works the same way in which we [the public] lend money off our own bank.

In reality, the larger leasing companies get a significant capital allowance so that they can continually order vehicles without asking the bank to lend them money. Smaller leasing companies will still get a capital allowance, but the money they are allowed to borrow will be substantially less. This industry is very much driven (excuse the pun) by the supply/demand/volume business model.

As you’d expect, the bank will charge interest on the loan amount (to the leasing company), which usually equates to less than 4%. In comparison, the average annual percentage rate (APR) on a personal loan in the UK is between 10% and 28%, based on your personal circumstances (risk). This means that a leasing company also has the flexibility to adjust their APR rate based on your personal circumstances; therefore adjusting the monthly contract hire rate accordingly.

So what we have, is a bank lending money to a leasing company (lending with interest), the leasing company with a cash allowance (borrowing with interest + tangible assets, i.e. vehicles), and the customer (borrowing with interest). The car is considered a fixed (tangible) asset and therefore carries some risk, however, there is capital stored in the asset, which helps mitigate some of the risks for the bank. In the event of non-payment(s), a leasing company will start the process of vehicle collection, which will be sold at market value, again, mitigating any risk a bank may have about the loan to the leasing company.

Everyone wins. The bank (interest), the leasing company (a new customer), and you (a new car).