Leasing or Financing?

Leasing or Financing?

When it comes time to buy a vehicle, the best and most responsible way to buy is via cash.  However, we cannot all afford to pay cash for a vehicle which leaves us two options: Finance the balance or Lease the vehicle.  What is the difference?  Does it matter?

What is the difference?

The basic difference between leasing and financing is found at the end of the term.  In leasing, a balance is left over (residual) and you typically return the vehicle as opposed to financing where the ending balance is zero and you receive the pink slip.

Understanding Leasing (The Basics)APR Savings

Leasing is basically renting the vehicle based on how much the bank thinks the vehicle will lose value over the term of the lease plus interest (lease factor) plus taxes.  For example, if you lease a vehicle valued at $30K over a 24-month term, the bank will determine what that vehicle is worth after 24 months, add interest, and then divide that amount by 24 (not quite that simple but you get the idea).  In our example, if the bank thinks the vehicle will be worth 20K after 24 months, then the majority of your payment will be the 10K lose in value plus interest and taxes.

In other words, the primary factor in determining how much your lease payment will be is the difference in value between the price you paid now and the value of the vehicle at the lease end.  This is a place where banks can add strange terms like 39-months to pad their exposure and make a worse deal for the consumer.  Never by an odd term lease.

Since it is hard to get the published residual values and current lease factors, leasing can be very easy for consumers to get a less than good deal.  Amounts can be hidden any number of places and unless you understand all components you can really get a bad deal.

Let me illustrate, part of the allure to leasing is the low monthly payments.  The payments are always lower than financing since depreciation will always be less than the full value of the vehicle.  That is the first trap since it is easy to ask a consumer what they can afford and tailor any lease payment to fit that request even though the payments could be lower.  For example, a typical vehicle will depreciate 30-40% of its value after 36 months, if your lease payments total more than that in 36-months you are getting a bad deal.

On a popular lease trading site, I saw a 2013 Ford Flex SE (base model) 39-month (note odd term) lease for $619 per month.  At $619 per month, the total payments are $24K, not including any money the person put down, for a $28K vehicle.  Basically the bank will get the vehicle back that is nearly paid off and turn around and sell it for $15-18K.  This person overpaid by at least $10K (probably more).   That dealer should be run out of business.

Understanding Financing (The Basics)

Financing is much more simple and harder to hide fees in a deal.  Financing is simply financing the final value of the vehicle after your down payment (and incentives) has been applied plus taxes and interest.

If you are financing your vehicle, unlike leasing, you can easily calculate what your payment should be based on the price you agree to pay for the vehicle less any cash or incentives applied.  On this site you can print out tables that calculate the payment or there are hundreds of web apps you can find to take with you to the dealer.  Either way, it is very clear how the numbers are calculated.  The only way the dealer can add expense is to either give you a higher interest rate than what you qualify for, add extra items like road vehicle insurance, or not apply incentives into the agreed upon price.

Does it matter?

Unfortunately, for most people leasing does not make sense but is consistently pushed due to the lower per month payments.  Leasing has a lot of downsides including more places to hide expenses, it is harder to calculate what your costs should be, you never own your vehicle unless you buy out the lease, residual values are not widely published, down payments are often lost in the formula, lease factors are hard to compare, mileage limits are placed in the contract, and fees are often added to the end of the lease if you do want to purchase the vehicle.

So with so many downsides why do people lease?  Well, if you fully understand all the numbers you can sometimes get a better deal leasing then financing, but it is very hard to know for sure.  Leasing also makes sense if you are a person that can afford to switch vehicles every two, three, or four years.  Some people just don’t want to own a vehicle beyond four years so leasing is an option for them.  However, if you keep leasing you will never have anything to show for the hard money you spend every month.

In summary, if you are in the market for a new vehicle, pay cash or finance.  Very few people have a need to lease and should avoid them.  Remember, you will never own or have any equity in a leased vehicle.  All the cash you pay is paying down the amount the vehicle is expected to lose value, buy its very definition it does not build any value.

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