With leasing, you only pay for the portion of a vehicle’s original value that you "use up," which is the amount by which it depreciates. For example, if you lease a car that costs $20,000, that is worth $13,000 after 24 months, you only pay for the $7000 difference, plus interest. When you buy, you pay for the entire car. |
|
This is fundamentally why leasing offers significantly lower monthly payments than buying.
Lease payments are made up of two parts: a depreciation charge and a finance charge. You pay the car's owner (the leasing company) for loss in value of its asset, as well as interest on the total amount of money they have tied up in the car while you're driving it.
Loan payments also have two parts: a principal charge and a finance charge. The principal charge pays off the vehicle's original full purchase price, while the finance charge is interest. However, since all vehicles depreciate the same amount regardless of whether they are leased or bought, part of the principal payment should be considered as a depreciation payment, exactly like leasing — it's money you never get back, even if you sell the vehicle in the future.
The remainder of the principal payment goes toward equity. Equity is resale value. It's what remains of your car's original value at the end of the loan after depreciation has taken its toll. It's the part you get back if you sell the vehicle. The longer you own the vehicle, the less equity you have.
So, buying a car with a loan is essentially like putting money into a declining-value savings account — you never get out as much as you put in. A terrible investment by any measure. Leasing, then, is almost like buying, but without the "savings account." You only pay for what you use. It's true that you own nothing at the end of a lease, but what you don't own is the same part of the car — the depreciated part — that a buyer too doesn't own at the end of his loan.
With leasing, you at least have the option of putting your monthly payment savings into more productive investments, such as mutual funds or stocks that have the possibility of increasing in value. In fact, many experts encourage this practice as one of the benefits of leasing, though most people will typically find other uses for the money they save by leasing — such as paying the mortgage or buying groceries. Does this mean that leasing is always a better way to go?
Not necessarily. Read on... Lease vs Buying - Which is Better?
