Car leases and car loans are simply two different methods of automobile financing. A car lease finances the use of a vehicle; a car loan finances the purchase of a vehicle. Each has its own benefits and drawbacks.
With a car loan, 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 car loan, and pay an interest rate determined by your loan company. You make your first payment a month after you sign your contract.
With a car lease, 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 not making a down payment, you pay sales tax only on your monthly payments (in most states), and pay a money factor that is similar to the interest rate on a loan. With car leases, you may also pay extra 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.
Loan vs. lease example
As an example, if you lease a car that costs $25,000, that will have an estimated value of $15,000 after 24 months, you pay for the $10,000 difference (this is called depreciation), plus finance charges, plus fees. When you buy, you pay the entire $25,000, plus finance charges, plus fees. This is fundamentally why a car lease has significantly lower monthly payments than a car loan.
Car 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 the end of the car lease.
Car 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 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 car loan payment can be considered as a depreciation charge, just like with a car lease — its money you never get back, even if you sell the vehicle in the future.
The remainder of each car loan principal payment goes toward equity. It's what remains of your car's original value at the end of the car 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.
Car lease
versus
car loan?
Let's simplify the answers and summarize them here:
1. The short-term monthly cost of a car lease is always significantly less than the cost of buying.For the same car, same price, same term, and same down payment, monthly lease payments will always be 30%-60% lower than loan payments. This is still true even when compared to 0% or low-interest loans.
2. The medium-term cost of a car lease is about the same as the cost of buying, assuming the buyer sells/trades their vehicle at the end of the car loan.The overall cost of a car lease compared to a car loan, over the same lease/loan term, is approximately the same, more or less, assuming the buyer sells the vehicle at the end of the car loan. Comparisons sometimes show a car loan to cost a little less than a car lease due to fewer fees, lower finance costs, and the assumption that a purchased vehicle will return full market value if it is sold or traded at the end of the car loan (often a bad assumption, especially if traded). However, when the benefits of wisely investing monthly lease savings are considered, the net cost of leasing can easily be less than buying.
3. The long-term cost of a car lease is always more than the cost of a car loan, assuming the buyer keeps the vehicle. If a buyer keeps his vehicle after the car loan has been paid off and drives it for many more years, the cost is spread over a longer term. It doesn't take rocket science to figure out that the cost of buying one car and driving it for ten years is less expensive than leasing or buying five different cars over the same period. Therefore, short-term leasing is always more expensive than long-term buying. If long-term financial benefits were the most important objective in acquiring a new car, it would always be best to buy the car and drive it for as long as it survives — or until the cost of maintenance and repairs begins to exceed the cost of replacing it. However, many automotive consumers have other objectives that reduce the importance of long-term cost savings.
