Leases and purchase loans are simply two different methods of equipment financing. One finances the use of equipment; the other finances the purchase of a equipment. Each has its own benefits and drawbacks.
When making a 'lease or buy' decision you must look not only at financial comparisons but also at your own personal priorities — what's important to you.
Is having a new vehicle or equipment every two or three years with no major repair risks more important than long-term cost? Or are long term cost savings more important than lower monthly payments? Is having some ownership in your vehicle or equipment more important than low up-front costs and no down payment? Is it important to you to pay off your vehicle and be debt-free for a while, even if it means higher monthly payments for the first few years?
So we find out that making a lease-or-buy decision is not quite cut and dry. There are some things you need to consider. Let's take a look at some of these things now.
First, it's important to understand that buying and leasing are fundamentally different, not just two versions of the same thing.
Buying and leasing are different
When you buy, you pay for the entire cost of the equipment, regardless of how many miles you drive it. You typically make a down payment, pay sales taxes in cash or roll them into your loan, and pay an interest rate determined by your loan company, based on your credit history. You make your first payment a month after you sign your contract. Later, you may decide to sell or trade the equipment for its depreciated resale value.
When you lease, you pay for only a portion of a equipment's cost, which is the part that you "use up" during the time you're driving it. You have the option of not making a down payment, you pay sales tax only on your monthly payments (in most states), and you pay a financial rate, called money factor, that is similar to the interest on a loan. You may also be required to pay fees and possibly a security deposit that you don't pay when you buy. You make your first payment at the time you sign your contract — for the month ahead. At lease-end, you may either return the equipment, or purchase it for its depreciated resale value.
Buy vs lease example
As an example, if you lease a $20,000 truck that will have, say, an estimated resale value of $13,000 after 24 months, you pay for the $7000 difference (this is called depreciation), plus finance charges, plus possible fees.
When you buy, you pay the entire $20,000, plus finance charges, plus possible fees.
This is fundamentally why leasing offers significantly lower monthly payments than buying.
How are lease and loan payments different?
Lease payments are made up of two parts: a depreciation charge and a finance charge. The depreciation part of each monthly payment compensates the leasing company for the portion of the vehicle's value that is lost during your lease. The finance part is interest on the money the lease company has tied up in the car while you're driving it. In effect, you are borrowing the money that the lease company used to buy the car from the dealer. You repay part of that money in monthly payments, and repay the remainder when you either buy or return the vehicle at lease-end.
Loan payments also have two parts: a principal charge and a finance charge, similar to lease payments. The principal pays off the full vehicle purchase price, while the finance charge is loan interest.
However, since all vehicles depreciate in value by the same amount regardless of whether they are leased or purchased, part of the principal charge of each loan payment can be considered as a depreciation charge, just like with leasing — it's money you never get back, even if you sell the vehicle in the future. It's lost money for which you'll have nothing to show.
The remainder of each loan principal payment goes toward equity. It's what remains of your car's original value at the end of the loan after depreciation has taken its toll. Equity is resale value. It's what you get back if you sell the vehicle. The longer you own and drive a vehicle, the less equity you have. At some point in time, after the wheels have fallen off and the engine is worn out, the only equity left is scrap value. You never get back the amount you've paid for your vehicle.
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