what is the difference between a car lease and finance

Lease vs. Finance: What’s the Difference for Your Next Car?

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Introduction to Car Leasing and Financing

You could say that leasing a car is similar to renting a car. When you lease, you pay to drive a vehicle that is owned by a company. You agree to pay, over the time you use the vehicle, the depreciation fee, plus finance charges, some taxes, and fees. When the lease ends, you return the car. Financing a car means you’re borrowing money and must pay ordinary finance charges and interest over time. Once financing is complete, you own the car clear and free.

When it comes time to find a new vehicle, there are many financial decisions to make, including whether to lease and what type of car financing to consider. When you buy a car, there are two principal ways to finance the purchase – taking out a loan and leasing. Whichever method you choose, you’ll walk away with a new car and a new financial obligation. However, there are important differences between the two, namely tied to ownership, obligations at contract end, and the return process. To understand whether financing or leasing a car is best for your financial situation, consider these differences before buying.

Key Differences Between Car Leasing and Financing

Loan Term. As you don’t own the car when you are leasing it, the terms don’t usually exceed 5 years. With a car loan, buyers are allowed to stretch out their loan terms for much longer periods. In addition to enabling buyers to stretch out payments, longer loan terms also often come with a lower rate of interest, potentially lowering payments.

Car Price. It is often higher when leasing. This is because, in order to be eligible for leasing, you should have good credit. In cases when a car is leased, its price is negotiated by the car owner with a dealer.

Down Payment. There are a number of cars whose purchase doesn’t require a down payment; however, its availability will affect your monthly payments. With car leasing, the amount ranges from several hundred dollars to several thousand. Similar to the down payment on financed cars, the down payment for a leased car isn’t refundable if the agreement is terminated early.

Differences between car leasing and car financing are often misunderstood. Leasing a car means an opportunity to upgrade your car every few years to a new one. Financing a car means actually owning it after you have paid off the total amount. In this case, you will have a tangible asset as a result. Both methods have their pros and cons, and your financial situation and your preferences have to be considered to decide.

Ownership of the Vehicle

First, we’ll examine ownership of the asset. When you finance an asset – that is, arrange a loan to pay for the asset – you repay the loan gradually, over time. When you’ve paid the loan in full, the asset – whether it’s a house, a business, capital equipment, or a car – is yours to keep. It’s fairly simple: you get the car, house, or other possession you want, but you also assume responsibility for it. When you finance your own house, the value of your house is recorded, and the debt on your house is recorded. The value of your house less the debt on your house is your equity – the value of the home that you own. This financial formula can be expressed in a simple equation: equity equals assets minus liabilities.

So, what’s the difference between financing a car and leasing one? Ownership. When you finance your car, you pay for its entire purchase price, interest and costs included, and the car is yours to keep. When you lease a car, you pay the difference between the car’s purchase price and its expected future value, a kind of fee for the time you use the car. When the lease is finished, the car goes back to the dealer, and you’ll be shopping for a new car again.

Monthly Payments and Interest Rates

If you buy a vehicle in a conventional finance contract, your interest rate is disclosed as the annual percentage rate (APR). This is the most accurate way to find out how expensive your loan is. The higher the interest rate or APR, the more interest you pay over the term of the loan and the more expensive your car becomes. By contrast, in a leasing contract, the interest rate is described as a money factor. While you could, with some simple arithmetic, figure out the equivalent APR, you should ask the lease representative or company to tell you the APR. With this method, you can then determine which company is giving you the better financing arrangement, with a lower APR and thus lower monthly payments. Look out for leasing companies which offer you a money factor but fudge the APR. You have a right to know it.

Your monthly payments will be much lower if you lease rather than buy your vehicle up front. Typically, monthly lease payments amount to 60% lower than your loan payments for the average car. That’s one of the big attractions of leasing. Your lease also includes finance charges, which are built into the monthly payments. This would be equivalent to the interest you pay when you take a loan to buy your vehicle. The higher the money factor, the higher your monthly lease payments will be. Your monthly lease payment will also be higher if you have a lower initial down payment at lease signing.

Mileage Restrictions and Wear-and-Tear

Mileage limits aren’t bad if you have a short commute to work or generally drive within a confined area. If you use public transportation for commuting, live in a larger city or urban area, or have other vehicles or heavy-use vehicles for commuting or long trips – and you can stay within the mileage limit – leasing may be a great option for you. Otherwise, leasing isn’t worth the cost. Few people want to worry about exceeding mileage limits, especially with the health or enjoyment of a vehicle. In addition, lease agreements also impose wear-and-tear penalties as well. At the end of the lease, the leasing company inspects the car, and any dents, scratches, and other physical problems will cost you a pretty penny.

When you lease a vehicle, the leasing company expects the car to be worth a certain amount at the end of the lease – equal to the estimated depreciation during the lease. However, the auto manufacturer places restrictions on the number of miles that can be driven, and additional mileage over the lease agreement results in a financial penalty. For example, the standard mileage allowance is 12,000 miles per year; 15,000 per year may be by special request. Excess mileage penalties typically cost 15 cents per mile, but can be as high as 25 cents per mile.

End of Term Options

At the end of your lease, you have the opportunity to take advantage of preferential lease-end rates and gain automatic lease end vehicle protection at no extra cost. If you wish to purchase your vehicle, you can do so at the guaranteed purchase option (GPO) price as specified in the fine print of your lease contract. This payable amount is known as the lease-end purchase price or lease-end residual value. The end of the lease presents you with the opportunity to finance the purchase of your vehicle with the in-dealership financing of your choice, to pay out the remaining balance in full funds or simply, to return the vehicle to the dealership as you had originally intended.

Lease End-Purchase Finance

Common end of term options include:

At the end of your finance contract, you will have full ownership of the vehicle and can keep it without having to make further payments. If you wish to trade-in your vehicle after the end of your contract, any remaining value after selling the vehicle will be an additional bonus to you.

End of Term Options

Insurance and Maintenance Costs

If you’re financing, try to find a car that comes with a nice long warranty. One of my cars is financed because it’s under warranty for four years, and the savings by not having a payment on it every month mean I can self-insure it myself. If you don’t cover your car payment with no problem, reduce compound interest by making payments bi-weekly instead of once a month. If you pay $300 every two weeks instead of $600 once a month, over the course of a year that’s $156 savings than you would have by making one payment each month. Some financial institutions already set your payment schedule to be bi-weekly, so find that out before you make your decision.

If you’re leasing a car, consider paying for gap insurance. Your payments go toward the car’s depreciation, and normal auto insurance doesn’t totally cover that. If the car’s stolen or destroyed, you may have to pay off that difference out-of-pocket. Gap insurance kicks in then, covering the rest of the car’s cost. A finance coverage plan is similar. The bank or credit union will require you to put the car’s value against your loan as a form of security, and they’ll expect course insurance that covers the vehicle’s entire cost. As I mentioned, leases are more likely to come with warranty, but if they don’t, they often provide some kind of short-term protection plan to cover repairs, oil changes, and other routine maintenance. If these costs aren’t rolled into your monthly payment, be prepared to pay for them separately.

Pros and Cons of Car Leasing

Leasing a car involves and is based on the financing principle that the lessee buys and uses the car, then pays the difference between the car’s price and its expected value at the end of the lease, plus a rental charge for the use of the car while the car is being driven. Renting a car is a form of financing because the real value of the car’s use is paid for as a rental cost, the forecast depreciation worth of the car is not funded, as it is with a normal financing merchandise.

If you like driving a new car every two or three years, want lower monthly payments, don’t like paying for major repair bills, trade in your vehicle every two to three years for a new one, drive an average number of miles, properly maintain your car, and have an opinion about your car, then you should lease your next car. Just be sure to consider any lease-end costs, as well as any up-front costs that you might face. And if you have extra money to spend on a new car payment, want to have ownership of your car, want to drive your car for more than a few years, put a lot of miles on your car, want to customize your car, and don’t care about the trade-in value of your car, then you should finance your next car.

Advantages of Leasing

The sales tax is less when you lease, because you only pay tax on the cost of the vehicle portion you finance. This accounts for part of why the monthly lease payments will be lower than the monthly finance costs; you’re not using after-tax paycheck money to purchase the car. Keep in mind, though, that you are not building up any equity by leasing a vehicle, and once your lease period is over, you must return the vehicle, usually within a few days, or you could be charged for a mileage penalty. The security deposit that you paid at the beginning of the lease should be returned as long as you have not incurred such penalties.

Perhaps the biggest advantage of leasing is the opportunity to drive a new car without committing to buying it. If you like to drive a new car every few years, leasing can make more sense than buying. Your costs are lower as well because you’re only paying for the use of the car for those few years, rather than paying to own the car outright.

Disadvantages of Leasing

Leased vehicles should not be altered in any fashion. Permanent, non-standard changes to the vehicle will likely necessitate repair expenses at the end of the lease to return the vehicle to its original state. For those buyers dedicated to owning the vehicle which they drive, leasing may not be the best method of acquiring a vehicle. Additionally, a prudent consumer must have a working knowledge of contractual details before agreeing to a lease, as leasing contracts have specific terms and clauses that a lessor may not be made aware of, or understand, at the time of the lease. Finally, at the end of the lease period, the vehicle has no resale value left for the lessee, unlike a vehicle owned by those who finance.

Disadvantages of Leasing Leasing has its drawbacks, too. There is generally a mileage restriction on leased vehicles. Typical mileage limits are 15,000 or 20,000 kilometers a year. If the vehicle is driven more than this limit, a penalty is levied at the end of the lease. If the need for a particular vehicle were to change, and the lessee is forced to end the lease early, an early buyout penalty may apply. Due to these factors, leasing should only be considered by those who are quite confident that the vehicle’s use will remain consistent throughout the term of the lease.

Lease vs. Finance: What’s the Difference for Your Next Car?

Pros and Cons of Car Financing

On the other hand, you will pay more for a new car if you finance. The longer you make payments, the more the car will cost because you will pay interest. You may also pay more for loan insurance (like life insurance to pay off the balance in case you die or become disabled). If the down payment is less than 20 percent, you will also have to pay extra interest on that amount as part of the monthly payment. When you are finished paying off the loan, there won’t be any more monthly expenses, such as a high car payment. However, you will still have to pay for normal related costs to operate the car. These expenses include fuel, insurance, maintenance, and repairs.

If you finance the car by taking out a loan, you’re the owner. The loan will get paid off over time and when it’s paid off, the lender will send a release of lien showing that the car is yours. Since you’re the owner, a lender won’t be able to repossess your car unless you fall behind on payments. One of the benefits of financing a car is that you can spread the payments out over time. If you can’t afford to pay cash for a car or make large payments, financing is probably not the right choice. When you are finished paying off the car, you own it. You can keep a car for a long time once it’s paid off, and the only costs should be for gas, insurance, and maintenance. The lender will not be involved in any ordinary transactions.

Advantages of Financing

Financing can also build a valuable asset that provides you with a pool of funds from which you can draw, if needed. Your vehicle has some secondary value that remains after the financing is paid off, even though the car is older and worth less than a new vehicle. You can obtain a home equity loan to use this value for renovations, debt consolidation or other needs. Note that you don’t have this option when you lease. In addition, vehicle finance is very straightforward. You may trim the size of the payments by paying a larger down payment or extending the payment period, while keeping your needs in sight. (In the latter case, it is beneficial to pay off the loan balance quickly.) A closer purchase of the vehicle with which you feel comfortable can be more desirable with a term purchase. You pick the models and trim levels you like. Changes, such as the color of the car, more miles annually, sound systems, or other possibilities, are determined by you. Whereas very few changes can be made to a predetermined lease agreement, you have the final decision on the financing of your vehicle. Finally, the vehicle’s use is not subject to the stringent conditions often placed on leasing. With leasing restrictions, retirement, military service, extreme modify, and quite a few other situations may dictate an early lease termination cost in the form of high fines. With financing, you possess the vehicle and a set of rules does not control its usage.

When you finance a car, you’re paying the full cost of the car without any reduction for the car’s used value at the end of the term. Because the full cost of the car is spread over a predetermined number of months, your car payments are typically higher than those under a lease. However, you own the car at the end of the term, so there’s value left after the last payment. In fact, the longer you keep the car after the loan is paid off, the less it costs you in comparison with leasing.

Disadvantages of Financing

Disadvantages with financing include some restrictions on the miles you can drive, charges for exceeding the limits, and continuing responsibilities for insurance and car upkeep after the warranty period. Some buyers have test-driven a car for a few days and then changed their minds. Whether they can actually return the car without breaking the law and paying the balance of their loan depends on the dealer’s willingness to cooperate. Some stay firm on a return policy, while others allow a cooling-off period in exchange for a fee.

Financing a car still means it’s yours once you pay off the loan. But that can take four years or longer and might have higher monthly payments. You’re also on your own for car repairs once warranties run out. If you’re worried about the long-term resale value of your car, leasing is far less of a risk. You have to try to estimate the trade-in or private-sale value in three to five years, something that’s difficult to predict. Because trade-in prices are generally lower than private-sale prices, you’ll usually come out ahead if you sell the car yourself.

Choosing Between a Car Lease and Finance

The buying out issue Given a three-year contract and monthly payments of $375, three years later you owe $16,200 on that contract. At the end of a lease, the disposition fee may commence another purchase through “backway” financing, often from Nixon, even though you may not be the leaseholder. Altogether, whichever method of providing transportation you opt for must fit the purpose of providing transportation. Once these factors are addressed in conjunction with your budget to determine which delivery method is viable, your decision should be a viable one.

Cost comparisons For people interested in driving, leasing is typically less costly. Your contract price dictates the estimated worth of the car at the completion of your contract, the “residual” worth, and is determined by the lessor. Consequently, payments vary. Economically, the most sound move should be writing a check and buying the car outright. That said, keeping a down payment minimal may be expected. Typically, at least $1500 – $2500 down. What’s more, monthly payments may be in excess of $400 and sometimes nearly $600 or more. In contrast, the monthly liability of leasing may be cut by half. If your driving is limited to work or school, leasing is worthy of examination. Of course, driving distance impacts a lot. When leases are drafted, monthly mileage allowances are negotiated. Known as “maintenance on your asset being leased,” mileage costs may run from 8-14 cents/mile.

Choosing a car lease or finance When deciding whether to lease or finance, several variables need addressing. Financing may sound appealing, but let’s consider a lease and what best fits your needs. The aim here is to provide a basic understanding of these methods – weighing the down payment, monthly obligations, vehicle usage, and the buy/movement plan. The purpose is for you to make a sound economical decision on something of this sense.

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