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You are here: Financial Calculators > Car Lease & Loan > Intro to "Buy or Lease a Car (Vehicle)?"

Intro to "Buy or Lease a Car (Vehicle)?"

 

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Purchasing a vehicle

Buy or Lease a Car? When we plan to acquire a car, a truck or any other kinds of vehicle, we always wonder what cost the most between financing and leasing. Financing is like a mortgage; you make payments on the vehicle until the balance reaches $0.00, and the car is yours at the end. In the case of long term leasing, you make payments to use the vehicle during the term. At the end, you don't own the vehicle but you have an option to buy it. The buying option is established on a lease contract and is call the residual value. The one who leases pay during the term the equivalent of the amount to finance minus the residual value, plus the other costs.

A common argument to choose leasing is that the monthly payments are smaller. Also, a lease gives the advantage to distant ourselves from the responsibility of being a car owner, which is an advantage considering that paying for a vehicle is not an investment. Indeed, all vehicles devaluate in time, so if you put money on an asset that depreciates, it is no longer an investment.

It is different although if you intend to use the vehicle for commercial purpose, like companies in the field of transportation, moving, delivery, courier, taxi, etc. The vehicle is necessary to generate income, so in this case it is an investment. Most companies go for leasing in order to obtain smaller payments and therefore boost their benefits, but a deeper analysis doesn't always give reason to the lease. Interest rate on the lease is often higher and some contracts tie the lessee to the value of the vehicle, which can be a heavy cost at the end of the term.

The difference between open-end lease and closed-end lease

We have to take into consideration that there are two types of long term lease: the open-end lease and the closed-end lease.

Companies normally engage themselves in a commercial open-end lease. It is often the only thing they can get since it protects the lessor (the one who lends the vehicle) from any abuse on the vehicle. The open-end lease makes the lessee (the one who rents the vehicle) responsible for the residual value written on the contract. This means that the lessee has to make sure the vehicle is worth the buying option at the end of the term. If it's not the case, the lessee has to pay the difference between the value of the vehicle and the residual value. If, for example, the lessee overuse the vehicle and at the end of the term and the vehicle is worth $10,000.00 instead of $25,000.00 written on the contract as the residual value, the lessee has to pay the $15,000.00 loss. The open-end lease ties the user to the depreciation of the collateral, which is a way to hold him from neglecting the vehicle.

Consumers that are involved in an open-end lease are responsible for only a part of the residual value. Depending of the area and the applied laws, the portion varies. Coming back to our example, and considering that in an open-end lease, the consumer is responsible for 20% of the residual value, the lessee would have to spent $5,000.00 at the end of the term, which is 20% of $25,000.00 instead of the full $15,000.00.

As for the closed-end lease, the lessee is not responsible of the residual value, but he can't surpass a certain amount of miles (or kilometers) and has to do the usual maintenance. It is a contract that normally applies on consumers. If the lessee stays within the limit of the miles (or kilometers) established on the contract, and do the usual maintenance on the car, the lessor guarantees the residual value and the user is not responsible for the depreciation. Taking the same example, if the vehicle is worth $10,000.00 instead of $25,000.00 written on the closed-end lease contract as the residual value, and the user didn't go over the mileage (or kilometer), the lessee doesn't pay anything for the loss. The lessees could bring back the vehicle without exercising his buying option. He has to pay some extra only if he goes over the mileage (or kilometer) or neglects the maintenance.

Minimizing the costs to purchase a vehicle

The main objective when getting a car, a truck or any other kind of vehicles, is to minimize the costs of the transaction. When you consider that you deposit money on an asset that depreciates, you can only generate losses, but, you can always limit it. It is then worth it to compare the two options and evaluate the costs.

The two costs that create a difference between leasing and financing a car are the costs of interests and taxes. There is always a way to reduce the costs of interests and taxes for both leasing and financing with a down payment, a vehicle exchange and the residual value. Although, leasing and financing react differently to the fluctuations.

In the case of a lease, the smaller payments give us the opportunity to save on the monthly payments. These savings could be invested every month. In that way, we can cumulate a good amount with the objective to pay the residual value at the end of the term. The gain of interests on the monthly investment grows during the entire term while continuing to save and invest. The amount can be used to purchase the vehicle at the residual value.

The idea behind this tactic is to reroute a portion of the payment that applies on an asset that depreciates, and apply it on an asset that appreciates. In that way, it is possible to counter the interests and reduce the costs of a vehicle with the same monthly payment used for the financing.

The costs calculator for leasing and financing a vehicle

The calculator evaluates your two options. Insert the amount of your future transaction and the calculator will indicate the monthly payments, as well as the other costs related to it. It compares the total amount of taxes and interests paid for the leasing and the financing. It also calculates the total cost of your transaction including the savings invested from the start and the ones made every month. To include all the variables and therefore evaluate the general transaction, the gain of interest made with the investment reduces the total cost of the transaction.

It also evaluates if the down payment and the exchange of an old vehicle is the best option. How? By comparing the taxes and interests saved with the down payment and the exchange versus a gain of interest if the amount of the down payment or exchange was invested instead. Since most of us need a vehicle, it is an excellent tool to optimize your finance.

The Scenario Chart for Leasing and Financing

The chart compares different possible scenario for one series of data entered on your transaction. It involves 6 columns including 3 scenarios, and the objective is to compare the costs of leasing and financing when purchasing the vehicle.

1st scenario: Leasing and financing without the down payment and the exchange
The chart shows the leasing and the financing without the down payment and the exchange from the transaction. The objective is to demonstrate the amount saved from the taxes and interests with the cash down and the exchange.

2nd scenario: Leasing and financing excluding the investment
The chart compares the leasing and the financing with the down payment and the exchange, but excludes the gain of interests made with the investment.

3rd scenario: Leasing and financing with the investment
The chart compares the leasing and the financing including the down payment, the exchange and the investment. The gain of interests made with the investment reduces the cost to purchase the vehicle. For example, if you were able to gain $3,000.00 in interest during your term in order to exercise your buying option at the residual value, the vehicle will cost you $3,000.00 less to acquire.

N.B.: In the case of the investment made in the beginning of the term, the 3rd scenario does not consider the disbursement effort. For example, if you invest $10,000.00 instead of applying it as a down payment, you will have to spend more on the monthly payments, taxes and interests, on top of the $10,000.00 invested somewhere else. But, at the end of the term, you recuperate the investment, as opposed to the down payment and the exchange that is amortized on the amount finance. Since the investment is not money you will lose over time, the 3rd scenario only considers the gain of interests from the investment made in the beginning, which reduces the acquisition cost.

 

Try the calculator Buy or Lease a Car (Vehicle)? >

 
 
 
 
Numbers in our calculators are rounded to two decimals.
The same calculations made in an Excel spreadsheet may differ slightly.

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