Fundamental Difference Whether to Finance or Lease
Automobile financing allows for the purchase of a vehicle. When you buy, you pay the entire cost of a vehicle regardless of how many kilometres you drive it. You typically make a down payment, pay all applicable taxes in cash or roll them into your loan, and pay an interest rate determined by your financial institution based on your credit worthiness. Most loans are for a term between 36 and 60 months, but can go up to 84 months. You make monthly payments and may pay off your loan at any time without penalty. You can pay less each month with a longer term, or you can shorten your term with a higher monthly payment to drive a new car sooner. Once the loan is paid off, you have an outright ownership of your vehicle also known as clear title.
Automobile leasing allows for the use of a vehicle during the lease term which is typically between 24 and 48 months, and up to 60 months. When you lease, you pay only for a portion of a vehicle’s cost, which is the part that you “use up” during the lease period. You have the option of not making a down payment, paying taxes only on your monthly payments and paying interest similar to what you would pay on a loan. You choose an allowance based on 16,000 to 24,000 kilometres of driving.
At the end of the lease term, you may either return the vehicle or purchase it for its depreciated resale value which is always spelled out in the lease contract. If you have driven the vehicle more than the allowable kilometres, and you hadn’t purchased extra kilometres upfront at a reduced rate beforehand, you will pay additional charges as specified in the lease contract.
Leasing Tip: Residual Value
Check the residual value of a car before signing a lease agreement. The residual value is what the car is worth at the end of your lease. The value is based on a percentage of the MSRP Manufacturer’s Suggested Retail Price, as set by the leasing company, not the dealer. The value has a big impact on your monthly lease payments, and may affect your choice of vehicle, plus whether you choose to buy the car at the end of your lease.
Here is how you calculate residual value and lease end value.
Confirm your car’s MSRP on the automaker’s website.
Request the residual value percentage rate from your leasing company – usually between 45% and 60% but can be lower or higher. The lower the percentage, the lower your monthly lease payments and the higher the residual value of your car at the end of the lease.
Calculate (MSRP) x (Residual Value %) = LEV Lease End Value
Example: $35,000 MSRP x 58% = $20,300 LEV residual value (the price you pay if you decide to buy the car at the end of your lease)
Top Tip: Higher Residual = Lower Monthly Lease Payments
Example: A $30,000 MSRP vehicle leased for 36 months with a residual value of $14,000, means you pay only $16,000 over three years. If the residual is $20,000, you pay only $10,000 over three years. You have lower monthly lease payments.*
* Offers, incentives, interest rates and taxes not factored into example.
So, now the question is which is better, leasing or financing? Well, that depends on what is important to you. Besides financial considerations, we all have different lifestyles and priorities to consider. We hope our ultimate side-by-side checklist helps your decision.
To summarize, leasing does not typically build equity with its lower monthly payments, while financing does. The reason equity is built for financing is because a portion of the higher monthly payments builds equity. The cost of financing one vehicle and driving it for ten or more years is definitely less expensive than leasing several vehicles over the same period. However, when your primary consideration isn’t financial, then other variables like the ones in our checklist will play a significant role in your decision-making process.
Good luck and happy decision-making.