Hey! I’ve been thinking about getting a new car and this would be my first time getting one so i don’t really know all the ins and outs. I really just wanted to come on here and ask what the difference between leasing and financing is. And any other advice on getting a car is welcome but not necessary. thank you!!
In: Economics
Leasing is a form of a long term rental where the lessee has certain rights as specified by the contract. For example, the lessee is responsible for registering the car and doing basic maintenance. You don’t typically need to do that if you rent from Hertz.
The benefits to leasing are the same benefits you get from leasing your housing, you aren’t ‘on the hook’ for it long term. Since you can give it back after three years, you don’t have to worry about depreciation, which is normally huge on so-called ‘lease machines’. A corollary benefit is that the lease contract usually includes a set value a the end of three years AND it gives you the right of first refusal *at that value* regardless of the actual value of the car. So, if you lease a $76,000 SUV and the reserve value is calculated to be $38,000, then at the end of the contract they must offer it to you at that price. If you are returning a lease and the salesman is desperate to get you into a new lease, chances are they figure they can sell your car used for more than the contract value if you buy it out.
You typically want to lease high value depreciation items. Boats, planes, cars, whatever. Hell, even movie studios typically lease cameras and lenses for shoots rather than own them. Half the planes that major airlines operate are actually leased from a holding company and are often re-leased out to a different airline. So united might lease the jet, then lease it to some other airline for some amount of time. Leasing is how you avoid the proverbial financial boat anchor.
The negatives to leasing are, mostly, that people don’t read the contract carefully. If you lease for 10,000 miles a year and do 15,000 AND want to give it back, you will be on the hook for the overages. There are often ‘outs’ to that, but again, you need to read the contract. It can also happen that if you LOVE the car and want to buy it, the reserve value may be higher than the resell value, so it might not be a great deal. If you plan to keep the vehicle for 10 years, then leasing doesn’t really make sense unless you are super artful about how you manage the buy-out.
Financing, which almost always takes the form of a simple interest loan, is a lot more straight forward. You and the bank buy the car from the dealer, then you make structured payments from 48-72 months until the balance is paid off. With rates being what they are, the finance charge on that SUV I mentioned above can be very high, like $10,000. What that means is after I have made all the payments, the total I will pay will be the price of the vehicle at time of purchase + all interest payments. The trick here is to pay as much as you can as soon as you can, 8% interest is a lot less painful on $20,000 of debt rather than $40,000 – which is close to the average of a new car. Thankfully, with simple interest loans, they can only charge you interest that has accrued to that day. So if you make your regularly scheduled payment, then pay again a week later, that payment will go wholly to principle minus 7 days of interest. Interest is calculated daily and applied monthly unless you are doing a payoff quote, then it is to the day. Additionally, the laws in the USA changed after 2008 and all but entirely eliminated early pay off fees.
If this all sounds very confusing, it is because it is, and that is by design. The financial industry thrives on making things seem harder than they actually are, if they didn’t then half the financial services jobs wouldn’t exist. To better arm yourself, familiarize yourself with the simple interest formula, the compound interest formula, amortization schedules (you can just download an excel template for that), interest rates, and typical loan terms and conditions. Investopedia is a great resource if you need more guidance.
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