Lease vs Buy Example
As an example, if you lease a $20,000 car that will have, say, an estimated resale value of $13,000 after 24 months, you pay for the $7000 difference (this is called depreciation), plus finance charges, plus possible fees.
When you buy, you pay the entire $20,000, plus finance charges, plus possible 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 money that the lease company used to buy the car from the dealer. You repay part of that money in monthly payments, and repay the remainder when you either buy or return the vehicle at lease-end.
Loan payments also have two parts: a principal charge and a finance charge, similar to lease payments. The principal pays off the full vehicle purchase price, while the finance charge is loan 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. It’s lost money for which you’ll have nothing to show.
The last paragraph is important to understand and misunderstood by most who believe that they drive too many miles to lease…’” all vehicles depreciate in value by the same amount regardless of whether they are leased or purchased”.
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. At some point in time, after the wheels have fallen off and the engine is worn out, the only equity left is scrap value. You never get back the amount you’ve paid for your vehicle.
The great illusion called “equity”. Equity is almost always misinterpreted and exacerbated when used in conjunction with a loan. We in the industry compound the problem by labeling the difference between the value of a vehicle and the payoff or loan, if greater, as equity. If the value is less it’s called a deficit. If ones paid cash for the vehicle what do we call it?
Equity is an illusion, created by time and payments. In other words, one has paid down their loan quicker than the vehicle has depreciated. There is never really equity in an automobile when you consider basis. In this example the basis is $20,000 and only if the car someday is worth more than $20,000 is equity or gain not an illusion.
Continued in Lease versus Buy Part III