Leasing vs. Buying
Automobile Leasing
Leasing is a form of financing in which you can use a vehicle for a period of time in exchange for making payments to the leasing company (lessor). In a lease, the lessor continues to own the vehicle.
Traditionally, leasing vehicles was popular with self-employed people and businesses that treated the vehicle as an expense, not as a personal vehicle. Consumer leasing exploded in the 1980s and was extremely popular in the 1990s; peaking in 1999. Since then, the market has moved back to purchasing, and leasing has declined 52 percent.
Many auto manufacturers, finance companies, banks and credit unions offer consumer leasing programs. In the 1990s, the Federal government regulated the industry by requiring all lease agreements to follow the same standards, regardless of the lessor. The regulations benefit consumers and have helped leasing remain a popular option, because consumers can compare lease deals easily and fairly.
As attractive as it may be, leasing may not fit everybody's needs and lifestyles. The following information will help you decide whether leasing or buying is the best option.
back to top
Leasing vs. Buying: What's the difference?
When you buy, you pay for the entire cost of the vehicle, regardless of how many miles you put on the vehicle. You customarily make a down payment, pay sales taxes at the point of purchase or have them included in your loan, and pay the interest rate arranged by your loan company.
When you lease, you pay for only a portion of a vehicle's original value, which is the part that you "use" during the time you're driving it. Traditionally, you have the option of not making a down payment, paying sales tax only on your monthly payments (in most states), and paying a money factor that is comparable with the interest rate on a loan. With leases you may pay additional, extra fees and possibly a security deposit, which are additional costs that you don't have to pay when you buy.
Interestingly enough, the amount that two similarly priced vehicles depreciate over the same length of time can vary quite a bit. For example: Brand A and Brand B each offer a 6-cylinder sedan that sells for $20,000. The Brand A model is worth $10,000 at the end of three years, and the Brand B model is worth $12,000. Assuming everything else is the same, the payment for the Brand A vehicle will be significantly higher than for Brand B.
back to top
Lease Payments vs. Loan Payments
The lease agreement will show that the payments are made up of two parts: a depreciation charge and a service or rent charge. The depreciation part compensates the lessor for the part of the vehicle's value that is lost during your lease. The service or rent charge is interest on the money the lessor has tied up in the vehicle while you're driving it.
The actual payment can vary from lessor to lessor. The Brand A vehicle could have different payments from different banks because each lessor uses their own method of determining the vehicle's future value. If one lessor thinks it will be $10,000, and the other $10,800, then the second one will have a lower payment (with everything else the same).
To compare, factors that affect how much the payment will be include: allowable mileage/year, service or rent charge (i.e., fee for use of the money), length of the lease, future value of the vehicle (i.e., residual value), and the amount paid to the lessor at lease inception (i.e., acquisition fee).
Factors that don't affect the payment, but could still affect your wallet, include an excess mileage charge for any miles over the allowable amount, excess wear and tear charges and any security deposit requirement.
Loan payments, like lease payments, also break into two parts: a principal charge and a finance charge. The principal charge pays off the vehicle's original purchase price, while the finance charge is interest.
Loan payments satisfy the interest first. The remainder contributes to the principal and creates equity. Equity is the amount of your vehicle's value you keep after the loan has been satisfied.
Leasing resembles buying, but without the equity. You only pay for what you use. It's true that you don't own the vehicle during a lease, and it's also true you are not paying to own it.
back to top
Other Important Leasing Information
Because leasing is, to some extent, more complicated, there are some important factors that should be considered and need mentioning.
If a situation arises where the lessee wants out of the lease before their contract has expired, the lessee has options. The lessee can:
- Find someone to assume the lease. This would require a call to the lessor asking if they allow "assumptions," and what their policy is on this. Expect a fee of about $300. This is also something you may want to ask about when negotiating your lease contract.
- Sell the vehicle. To do this the lessee would call the bank and ask for the current buy-out amount. Once the lessee gets the figure, they should look up the market value of the vehicle and make sure to make adjustments for mileage, region, color and options. If the buy-out figure is close to the current market value figure, the lessee can sell the vehicle and pay off the lease.
- Turn in the vehicle to the lessor and walk away from the lease. This is the worst possible choice because it will go on your credit report as a “repossession.”
At the end of the lease, when it is time to turn in the leased vehicle, the lessor will inspect its condition and will charge the lessee extra for any wear and tear and any deviations from the lease contract. The lessee can try to avoid these charges by visually inspecting and noting any obvious blemishes and taking pictures of the vehicle at the lease inception, by staying within your mileage limit, making needed repairs, and keeping the vehicle at a condition above average. Additionally, lessees should fill out a condition report of the vehicle right before turning the vehicle in to the lessor.
At the end of the lease, the lessee has the option to buy, sell or turn in the vehicle, as explained above.
In order to buy the leased vehicle, the lessee needs to first look at their lease and find the dollar amount that is stated as the cost of the leased vehicle if it were to be purchased at the end of the lease. This is the residual value. Once the lessee has figured out what the lessor will be asking for the vehicle, the lessee should do some research and try to determine the vehicle's current market value as well as the current wholesale value and use this to negotiate with the lessor. This is worth a try for the lessee; however, generally the purchase price on the lease contract is what is paid if the lessee wants to purchase the vehicle.
Many of the complications or complaints regarding leasing can be prevented by negotiating a fair lease in the first place. The lessee should consult with someone whom they consider knowledgeable with regard to contracts, and an accountant or tax professional regarding possible tax advantages.
back to top
Leasing vs. Buying: Which is Better?
Deciding between a purchase and a lease is generally more of a lifestyle question than a financial one.
Leasing tends to benefit people who regularly get a new vehicle, every three to four years or so, and who prefer not to worry about any major mechanical repairs. Most lease vehicles are covered by the manufacturer's warranty for the term of the lease. Leases typically require small amounts of cash at inception, usually the first payment and a security deposit.
The down side is the condition and the insurance. People who lease need to be aware of mileage charges that can occur, and they must return the vehicle in good condition. Each leasing company has its own idea of what constitutes "good," but broken or missing parts and collision damage will result in additional charges. The leasing company may require insurance coverage greater than what a buyer would normally carry and that can add to the expense of leasing.
Purchasing tends to benefit people who keep their vehicle for a long time, or drive a lot of miles, and have a down payment or a trade. In the beginning, the owner absorbs the immediate depreciation of the vehicle. If they properly maintain it, the vehicle could last for years beyond the payments, and reward the owner with payment-free miles.