Listen – this is a long read. It’s okay if you don’t want to read it all. We can chat about it and figure out what’s best for you.
Leasing – lower payments, no equity.
Buying – higher payments, partial equity.
Lease versus Buy?
The answer is – it depends. It’s not possible to simply say that one is always better than the other because the answer depends on the specifics of each individual situation.
Leases and purchase loans are simply two different methods of automobile financing. One finances the use of a vehicle; the other finances the purchase of a vehicle. Each has its own benefits and drawbacks.
The statement in the previous paragraph “One finances the use of a vehicle” is often misunderstood. It implies that one finances only a portion of the vehicle if leasing when in fact you finance the same amount as with a purchase, the difference is that you pay back less.
When making a ‘lease or buy’ decision you must look not only at financial comparisons but also at your own personal priorities — what’s important to you.
Is having a new vehicle every two to four years with no major repair risks more important than long-term cost? Or are long term cost savings more important than lower monthly payments? Is having some ownership in your vehicle more important than low up-front costs and no down payment? Is it important to you to pay off your vehicle and be debt-free for a while, even if it means higher monthly payments?
So we find out that making a lease-or-buy decision is not quite cut and dry. There are some things you need to consider. Let’s take a look at some of these things.
An important consideration in evaluating the two options is whether one uses their vehicle for business. The tax deduction for business usage requires that one use their vehicle at least 50% of the time for business before any deduction can occur.
First, it’s important to understand that buying and leasing are fundamentally different, not just two versions of the same thing.
Buying and leasing are different
When you buy, you pay for the entire cost of a vehicle; regardless of how many miles you drive it. You typically make a down payment, pay sales taxes in cash or roll them into your loan, and pay an interest rate determined by your loan company, based on your credit history. You make your first payment a month after you sign your contract. Later, you may decide to sell or trade the vehicle for its depreciated resale value.
When you lease, you pay for only a portion of a vehicle’s cost, which is the part that you “use up” during the time you’re driving it. You have the option of not making a down payment, you pay sales tax only on your monthly payments (in most states), and you pay a financial rate, called money factor, that is similar to the interest on a loan. You may also be required to pay fees and possibly a security deposit that you don’t pay when you buy. You make your first payment at the time you sign your contract — for the month ahead. At lease-end, you may either return the vehicle, or purchase it for its depreciated resale value (in most instances).
Lease vs Buy Fees
The “fees” are Acquisition Fee, Disposition Fee and Purchase Option Fee. They are separate fees that add to the cost of leasing. The Acquisition Fee however is of great value to the lessee and is important to know what it includes.
- GAP Insurance – Most leases have automatic built-in gap coverage, while car loans do not unless purchased separately. Gap coverage pays the difference or deficit between what you owe on your vehicle and what it is worth if your vehicle is stolen or destroyed in an accident.
- Residual Value Insurance – The resale value of the vehicle is guaranteed in a closed end lease (excluding excess wear & tear and excess mileage). The lessor will buy insurance or self insure in order to guarantee the value. Acquisition Fees have gone up significantly over the years, so has the cost of insuring resale value.
- CarFax – An adverse CarFax report can have a significant impact on a cars resale value. The residual value or resale value guaranteed in a closed end lease protects the lessee from the loss of value in the event of an accident that negatively impacts the value of the vehicle.
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.
Buy Versus Lease – Savings Account or No Savings Account
So, buying a car with a loan is essentially like putting money into a declining-value savings account — you never get out as much as you put in. A portion of every payment you make is lost to depreciation and finance charges. What you have “to show” for your investment when your loan is paid off is only the part that is left over after depreciation and interest. A terrible investment by any measure. But cars are not usually purchased as investments, are they?
Leasing, then, is similar to buying, but without the equity “savings account.” You only pay for what you use and you don’t put anything extra into “savings.” It’s true that you’ll own nothing at the end of a lease; you’ll have nothing “to show” for the money you’ve put into it. But… what you don’t own is the same part of the car’s original value — the depreciated part — that a buyer too doesn’t own at the end of his loan. Again, a car’s value depreciates the same amount whether it is leased or purchased. That money is gone forever, lease or buy.
These last two paragraph’s address a common misconception when one chooses to buy versus lease because one wants to have something “to show” for their investment. In fact, if one uses a lease correctly i.e. the money saved in the monthly payment being invested into an increasing-value savings account you most certainly have something “to show” for choosing to lease.
With leasing, you may have the option of putting your monthly payment savings into more productive investments, such as mutual funds or stocks that have the possibility of increasing in value. In fact, many experts encourage this practice as one of the benefits of leasing, though most people will typically find other uses for the money they save by leasing — such as paying the mortgage or buying groceries.
If a lessee has any other outstanding debt, particularly at a higher interest rate than the lease, the money saved may also be used to pay off those debts.
To summarize, leasing typically does not build equity, while buying does. The reason that a buyer has equity at the end of his loan is that he purchases that equity by making higher monthly payments. Part of each payment funds the equity. Leasing – lower payments, no equity. Buying – higher payments, partial equity.