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It's a common dilemma: lease or buy, buy or lease, which is better?.
Everyone who has ever considered leasing their car has had this question cross their mind. So what is the answer?
It depends:
- Leases and loans are simply two different methods of car financing. One finances the use of a vehicle; the other finances the purchase of a vehicle. Each has its own benefits and drawbacks.
- It's not possible to simply say that one is always better than the other because it depends on your own particular situation and preferences.
- You must not only look at the financial comparisons but also at your own personal priorities — what's important to you.
- Is having a new vehicle every two or three years with no major repair risks more important than long-term cost? Are long term cost savings more important than lower monthly payments? Is ownership more important than low up-front costs and no down payment?
- So, making the lease or buy decision is not quite cut and dry. There are some things you need to consider first.
Buying and leasing are different
When you buy a car , you pay for the entire cost of a vehicle, regardless of how many miles you drive it. You typically make a larger down payment and pay an interest rate determined by your loan company. You make your first payment a month after you sign your contract.
When you lease a car , you pay for only a portion of the vehicle's cost, which is the part that you "use up" during the time you're driving it. You have the option of making a low down payment and pay a money factor that is similar to the interest rate on a loan. You make your first payment at the time you sign your contract.
Buy vs lease example
As an example, if you lease a car that costs £10,000, but is worth £6,500 after 24 months, you pay for the £3,500 difference (this is called depreciation), plus finance charges, plus fees.
When you buy, you pay the entire £10,000, plus finance charges, plus fees.
This is fundamentally why leasing offers significantly lower monthly payments than buying.
Lease payments are made up of two parts: a depreciation charge and a finance charge. The depreciation part of each monthly payment compensates the leasing company for the portion of the vehicle's value that is lost during your lease. The finance part is interest on the money the lease company has tied up in the car while you're driving it. In effect, you are borrowing the lease company's money that they used to buy the car from the dealer.
Loan payments also have two parts: a principal charge and a finance charge, similar to lease payments. The principal pays off the vehicle purchase price, while the finance charge is interest.
However, since all vehicles depreciate in value by the same amount regardless of whether they are leased or purchased, part of the principal charge of each loan payment can be considered as a depreciation charge, just like with leasing — it's money you never get back, even if you sell the vehicle in the future.
The remainder of each loan principal payment goes toward equity. It's what remains of your car's original value at the end of the loan after depreciation has taken its toll. Equity is resale value. It's what you get back if you sell the vehicle. The longer you own and drive a vehicle, the less equity you have.
Our next page discusses exactly What is car leasing?
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