Balloon Leasing is a way of getting the use of a vehicle without taking ownership of it.

The leasing period (or 'term') is usually a number of months or years during which the vehicle is still owned by the leasing company (the 'lessor') but is rented to the user (the 'lessee').

Effectively the user is borrowing the vehicle from the lessor for a fixed period in return for a lease payment (or 'rental').

What Is In Balloon Lease Rentals?

During the lease period the lessee pays a rental to the leasing company which covers the costs incurred by the lessor to operate the vehicle, plus a profit for the lessor.

In other words, the lessee pays for:

• The depreciation in the value of the car over the life of the lease
• Vehicle Excise Duty
• Interest Charges on the money borrowed by the lessor to buy the vehicle on behalf of the lessee
• The lessor's profit margin (which might be just the interest charges)
• VAT
• Maintenance (Optional)

At the end of the lease period the lessee normally returns the vehicle to the leasing company (though some leases may have a "run-on" clause allowing the vehicle to continue under lease for much lower lease rentals).

The leasing company disposes of the vehicle and pays the lessee a proportion of the residual value obtained on the sale. This repayment is referred to as a rebate of rentals and includes VAT.

Because the lessee pays only for depreciation during the period of the lease (the 'term'), as each monthly payment is made the lessee reduces the outstanding amount financed at a much slower rate than in 'fully amortised' leases.

Because less of the purchase price is repaid in each payment, assuming interest rates are the same in both fully amortised and balloon leases, the total interest charges in a balloon lease are more than those in a fully amortised lease (because more money is left unpaid during the term), so the overall costs of finance for a balloon lease are higher than those of a fully amortised lease.

However, repaying a lower amount of the purchase price each month means that the actual monthly payments are lower in balloon leases than for a fully amortised.

Advantages of Balloon Leasing

For passenger cars, because the leasing company recovers VAT on the price of the vehicle, the rentals for passenger cars will be lower than comparable finance instalments for contract purchase (where VAT on the purchase price is not usually recoverable for a purchaser).

Because the vehicle is leased, the normal responsibilities of ownership, such as sourcing the best deal and obtaining the best resale value, may be avoided if the leasing company already has supply and disposal arrangements.

The lessee may also profit from prudent management of the vehicle, such as achieving a better resale price than expected and therefore a higher rebate of rentals.

Disadvantages of Balloon Leasing

The lessee is normally at risk for the residual value of the vehicle at the end of the lease, so under accounting conventions applying at the date of publication, leasing must be disclosed on the balance sheet of a business as a liability. This status can worsen the appearance of the financial position of a business.

If the lease agreement is terminated earlier than expected then the lessee may be required to pay a penalty (usually a number of months rentals).

VAT incurred on the lease rentals cannot be recovered in full on passenger cars used for private purposes by employees - only 50% of the VAT incurred can be recovered.

Tax relief for the lessee on cars with a CO2 output over 110g/km is restricted (50GP/Km from April 2021), thereby increasing the total costs of leasing for cars with higher CO2 emissions.

Lease or Buy?

To see the cost impact of leasing or buying your next new car or van click here.