In a typical car lease agreement, you use a vehicle during a specific period-say, two to four years-and you consent to keep the car in good shape. If you are approved for a car loan, you own the vehicle as long as you stay current on your monthly payments-otherwise a repo man might pay you (and "your" car) a surprised visit in the middle of the night. Car leases and loans involve credit risk, so lenders and auto loan companies would routinely evaluate your credit history before approving your loan or lease application. To better understand the difference between a car lease and a vehicle loan, let me walk you through key factors such as term, vehicle type, and ownership, as well as upfront costs, insurance requirements, monthly payments, and early-termination fees. Then, at the end, I will give you a quick, nice summary indicating the pros and cons of each car financing path.
You can get a lease term spanning a few months to five years, but leases with longer intervals are not uncommon. A bank typically would grant you a car loan with a term ranging from four to six years.
With a lease agreement, you can expect to drive a new automobile every two years or so because of the shorter maturity of the agreement. Given the typical extended term of a car loan, don't expect to drive a new car that often.
You will not own a leased vehicle at the end of the contract unless you reach an agreement with the lessor-that is, the company leasing you the vehicle. When you borrow to buy a car, you own it as long as you make payments on time and abide by other contractual terms, such as buying comprehensive insurance during the loan term.
In a lease agreement, initial costs range from registration fees and sales taxes to down payment, security deposit and first monthly payment. With a car loan, upfront expenses include sales taxes and down payment along with taxes, registration fees, and other expenses. Normally, upfront costs for a car loan exceed initial expenses for a lease.
Lease payments typically are lower than loan remittances. To calculate your monthly payment, the leasing agency takes into account things like depreciation during the lease term, taxes, and rent charges. To compute your monthly loan payment, the lender factors into the equation things like purchase price, taxes, and interest charges.
You pay lower premiums in a car loan agreement than you do in a lease contract.
You can pay off the car loan as soon as you want, and normally there is no prepayment penalty. The lessor may charge you an early-termination fee if you cancel your contract before the term stipulated in the agreement.
The lessor expects you, the lessee, to return the vehicle at the end of the lease term. You should expect to pay end-of-lease charges, but inquire upfront with the leasing agency. There is no need to return a car you borrowed to pay for, so the vehicle is all yours once you extinguish the debt.
With a car loan, you own the vehicle and thus bear the risk of depreciation. If you car's worth goes down at the end of the loan term and you decide to sell it, the bank would have nothing to do with the loss or profit you reap. In a lease agreement, the lessor bears the risk of monetary reduction in the value of the vehicle.
During the lease term, the lessor expects you to take care of the vehicle, that is, to be responsible for its maintenance. The same is true if you borrow to pay for a car.
There's no limit on how many miles you can drive if you borrow to purchase an automobile. The situation is different with a lease, as the lessor generally would impose a vehicle mileage restriction. If you exceed that odometer threshold, you would pay extra when you return the car.
Upon return of the vehicle, you might have to dole out extra cash if the lessor thinks that the car's wear and tear exceeds contractual limits. You don't bear such risk with a car loan, but remember that the more wear and tear your car endures, the lesser the trade-in or resale price you can expect.
End of Term
At the end of the lease term, you have three options: purchase the vehicle at its residual value, return the vehicle, or lease another car. At the end of the loan term, the automobile is yours.
To sum up, let's quickly review the pros and cons of a car lease and a vehicle loan.
Getting a loan to buy a used or new vehicle
- Your car insurance coverage will cost you less
- You own the car, so you can change things inside and outside the vehicle as you wish
- You don't pay penalties if something happens to the car, be inside the vehicle or on its body
- You are free to drive as long as you wish-there is no mileage limit
- You will take full possession of the car, legally speaking, after paying off the loan
- You will pay more in loan installments than lease payments
- You must pay for repairs yourself
- You may have to make a hefty down payment before the dealer or bank approves the loan
- Your car loses value as soon you drive it off the dealer's premises, and depreciation eventually will reduce the vehicle's resale price
Leasing a Car
- You can deduct lease payments on your tax return if you use the automobile with a business perspective
- You make a small down payment
- Your lease payments are lower than what you would pay by taking out a loan
- You wouldn't care about things like depreciation-and major mechanical breakdowns you didn't cause
- You can lease a vehicle even if you had no or subpar credit
- You may not pay sales taxes upfront, depending on the state you live in
- You pay higher insurance premiums
- You incur penalties if something defective happens to the car
- Your mileage is limited; you pay fees if you go past the assigned mileage threshold
- You could be making lease payments indefinitely-say, over 20 or 30 years-and the car will never be yours