Loan Advice

Lease vs. Loan: What is the Difference

by Ana-Maria Sanders   Sep 15, 2021

Leasing and financing are two forms of asset acquisition. Depending on your financial situation, short-term and long-term goals, both options have their advantages and disadvantages. It’s best to compare a lease vs. loan side by side to see which one is right for your situation.

What’s a Lease?

Man signing lease.

A lease is a contractual agreement between the owner and the user of the asset for a specified time mentioned in the lease agreement. The owner and the user of the asset are not the same people. The lessee will pay money to the lessor for the usage of the asset in return. At the end of the lease contract, the parties have four options:

  1. Return the asset to the lessor
  2. Renew the leasing period
  3. Buy the asset at a low cost if the lessor agrees
  4. Re-lease the current asset with another one

While leasing an asset, you may come across lease brokers. They are the intermediary between the lessor and the lessee who helps the parties enter a lease agreement. You may also encounter lease financiers such as financial institutions and commercial or foreign banks. The lease financiers provide financial assistance for the lessor to enter into a leasing agreement.

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There are many types of leases, but operating leases and financial leases are the most common.

An operating lease is a short-term contract. The lessee is only responsible for making the lease payments. The lessor pays for all the expenses such as repairs, taxes, and maintenance. Risks and rewards are not entirely transferred to the lessee.

A financial lease is a long-term contract. The ownership of the asset is transferred to the lessee. The lessee bears all the expenses, including insurance, maintenance, taxes, and other applicable costs associated with the leased asset. In addition, the lessor transfers all the risks and rewards related to the lessee.

Most Commonly Leased Items

Instead of getting an equipment loan, most people opt for an equipment lease, especially in the following categories:

  • Transportation equipment such as trailers and vehicles
  • Medical and laboratory equipment such as X-ray machines, CT scanners, MRI lasers
  • Construction equipment such as tractors, forklifts, and loaders
  • Hospitality equipment such as stoves, refrigerators, tables, and chairs
  • Manufacturing and production equipment such as tanks, generators, and packaging machinery
  • Fitness equipment such as treadmill and rowing machine
  • Audio-visual equipment such as projectors, speakers, microphones
  • IT equipment such as hardware and software

Equipment leasing will not show on the balance sheet of the company.

What’s a Loan?

Man stares at illustration of money and question marks.

Loans are borrowed money to finance something that you cannot afford upfront. Lenders such as banks and credit unions can give borrowers a fixed amount of cash called “principal”. But lenders provide you with money at a cost. In addition to paying back the principal amount, borrowers are required to pay interest. When you make timely payments on your loan, you can build a positive credit history.

There are different types of loans to suit individual needs. These include student loans for tuition, small business loans for entrepreneurs, mortgage loans for buying a property, auto loans to get a vehicle, cash advance loans, and payday loans for emergencies. The financial institution you borrowed the money from will set up a repayment plan with you, including the interest rate and other applicable fees.

The interest rate of a loan is influenced by different factors such as the applicant’s credit score, loan type, and the amount borrowed. For example, higher credit scores qualify for lower rates. Additionally, there are two types of interest rates: fixed rate and variable rate. A fixed interest rate remains unchanged through the entire term loan. The variable rate is based on a chosen index and a fixed margin. If the index increases or decreases, so does the variable rate. The index is the benchmark interest rate that reflects market conditions and alters based on the market. The margin is the amount set by your lender when applying for a loan. The index and margin are combined to determine your interest rate when the initial rate expires.

Also, loans can either be secured or unsecured, depending on whether they are protected by collateral or not. Collateral is a valuable asset like your house or vehicle that the lender can take as repayment if you default on your loan. Secured loans usually have a more attractive interest rate since they are less risky to the lender than unsecured loans because they are protected by collateral.

Lease or Loan? The Major Differences

Woman comparing documents next to laptop.

What makes leasing and financing similar is that both require monthly payments. Other than this fact, leasing and getting a loan have significant differences. The table below shows the difference between loan and lease and helps you get a better understanding of the two.

  Lease Loan

Duration

Longer

Shorter

Down payment

0% to 6% of the original amount

10% to 20% of the original amount

Ownership of Asset

The lessor is the owner of the asset

The borrower/buyer is the owner of the asset

Monthly payments

More affordable

More expensive

Amount financed

Up to 100%

60% to 80%

Collateral

The collateral is the asset that you are leasing

Typically, yes, but it also depends on the type of the loan

Documentation Process

Faster

Lengthy

Leasing vs. Financing a Car

A car is the most expensive purchase most people make that, over time, decreases in value. If you can’t afford to pay for the entire amount of the vehicle upfront, you are left with two options: leasing or financing.

Leasing a car is like agreeing to rent it for a fixed term of three to five years. You pay a security deposit and make monthly payments based on the expected value of depreciation. At the end of the lease term, you can return the leased car, start the process over again by signing another lease deal and getting a new car, or buying it from the dealer for its residual value. In all cases, if you have excessively damaged the leased vehicle, you will have to pay an extra fee. In addition, leasing has restrictions such as mileage limits. If you pass the mileage limit, you must pay additional fees.

Financing a car means buying it with the help of an auto loan. You pay a deposit and make monthly payments. A car loan term ranges from four to five years. Once you pay back your auto loan, you are the owner of the vehicle. You don’t have to worry about damages to your car, mileage limit, or penalties because it is your property.

Leasing payments are lower than auto loan payments because the cost of the lease is based on the depreciation of the vehicle. Thus, you pay the difference in the car’s value from the start of the lease and the value at the end of the lease, plus interest.

If you prefer to switch cars every few years to drive the latest styles and make lower monthly payments, then an auto lease is the best option. But if you are someone who drives lots of miles and doesn’t want to make any monthly payments anymore, then getting a car loan is the right option for you.

Read the table below to understand the difference between financing and leasing, and make a better-informed decision based on your needs.

Pros of Leasing a Car Cons of Leasing a Car Pros of Financing a Car Cons of Financing a Car

Get a new model every lease term

Mileage restriction and penalties

Unlimited mileage usage

Responsible for selling car

Price is determined by depreciation

Excess wear and tear fees

Asset can be used as collateral

Car quickly loses value

You don’t have to worry about selling the car

Early trade penalty

No restrictions on who can drive

Down payment

A car lease is often covered by warranty

No customization

Customization

Responsible for maintenance  

Lower monthly payments

Infinite monthly payments (upon renewal)

Finite monthly payments

Higher monthly payments

You can choose to buy the vehicle at the end of the lease term

No ownership if you don’t want to finance the leased vehicle at the end of the term

Ownership

Paying sales tax upon purchase

Leasing vs. Financing a House

Owning your own house is no doubt a dream for a lot of people. However, many have chosen to lease with rising house prices across the past ten to fifteen years.

Renting is better if you plan to live in the home for a short term. The cost of renting is significantly cheaper than buying something and then selling it after only a few years. Even with selling, there is no guarantee that the market will continue to rise to afford a break even or profit point.

Also, most finance experts view home ownership as a liability rather than an investment because investing money in a home means less money is available to invest elsewhere with a potentially higher return. Moreover, rent costs are lower than the monthly mortgage fee.

There is a lot to consider when weighing such a big decision — renting and buying each come with their pros and cons.

Pros of Leasing Cons of Leasing Pros of Buying Cons of Buying

Total mobility and flexibility at the end of the lease

More expensive in the long term

More affordable car payment in the short term

Putting down a substantial deposit

Not responsible for maintenance

Less control of your living environment, you can’t make changes to the property without your landlord’s approval

Total control to make alterations

HOA fees

No need to sell the house

No control over annual rent fluctuations

Option to potentially deduct mortgage interest paid, which can lower taxes and build equity

Could have used your down payment in a business that could generate much higher returns

Low down payment

Limited housing security

Offers a sense of security and stability

Additional costs such as repairs, maintenance, property tax, and homeowners’ insurance

Ability to invest your money instead of paying for a down payment

Moving costs

No landlord

Landlord

Not liable for unexpected expenses

 

 

Closing costs and other purchasing fees

Credit requirements are less stringent

 

 

 

High-interest rates

Sum Up

Whether to lease or finance is a case-by-case situation. There are expenses on both sides of the spectrum, as well as advantages and disadvantages to consider. In the end, deciding to lease or finance is a personal decision, and only you can choose what is suitable for you. So do your research, look at your finances, personal priorities, current situation, and consider all of your options to make an informed decision.

Ana-Maria Sanders, author at OpenLoans
Financial Analyst
Ana-Maria Sanders writes about consumer and business finance. She has been featured on Business.com, CreditCards.com, FOX News, and FOX 29.
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