Difference Between Lease And Loan (With Examples)

Time is money. And if you treat it as such, you can make the best use of your money.

For example, you might want to get a car or a house. Or if you own a business, you may need to get a local and some equipment. And none of these purchases are cheap.

How you finance these assets is generally with a job, which is a very limited income stream. And when it comes to big purchases, it may take you YEARS of work before you can afford them.

However, if you’re financially responsible, there is a shortcut. You don’t need to trade so much time for those assets. Instead, you can borrow money to enjoy them today. And by saving time, you’ll potentially save money.

For this purpose, you might have thought of buying or renting. But since these are often expensive, borrowing might be a better move: to pay as you use the asset.

And if your goal is to own the asset, you have two choices:

a. To buy it (with a loan if you can’t afford it)

b. Or to lease it (to rent with a purchase option)

You could borrow, but do you have a reliable repayment play? You could lease instead, but is it really better than buying?

Which one is the right one for you?

The Difference Between Lease and Loan

The Difference Between Lease and Loan

Leasing, financing, buying, renting. All these terms look similar and it’s easy to confuse when you first hear them.

In plain words, a loan is borrowing money for interest. And a lease is a rent agreement with a purchase option (long-term oriented, 3-5 years). 

You first make a downpayment, which allows you to buy the asset at the end of the agreement. You then follow up on your monthly rental payments.

Plus, most sellers offer lease options, where they lower your monthly payments when increasing your down payment.

And when the lease ends, you have these options:

a. To return the asset and walk away (without equity). If this is your intention, consider renting instead

b. To buy the asset, getting the equity and ownership. Perfect if you’d like to own but don’t want to wait until you earn the purchase price

c. To trade in the asset (car for car, property for property). A great choice if you just want to use the asset. Because you can get back your down payment, lower rent, and keep your equity

d. To buy the asset and resell it for higher. While it makes sense, your profit margins will increase if you buy or take a loan instead

Aside from having more options, what makes leases different from loans is flexibility. It’s easier to approve a lease than a loan because you have no ownership. At the same time, the asset you use works as collateral they can retrieve.

You may wonder, how can monthly payments be lower than when renting? Because in a rent agreement, the owner has to cover maintenance costs. In a lease, you’re responsible for maintenance. So these won’t appear on the rent.

Is it financially smart? If you return the asset, you lose the downpayment and equity, so it’s not. If you trade-in, buy or resell, it is. And how you maintain the asset determines its appraised value at the end of the contract.

Before we look at the pros, cons, and features, here are examples where these tools become useful.

Example: Leasing a property

Let’s keep numbers simple. Suppose you invest in a $150K home with a mortgage of $1000 per month. You hope that if you increase the property value, you can sell it for a profit. The appraised value is $200K.

Of course, you could look for buyers. But not everyone is willing to drop $150K+. They want to think about it, see other properties, and pay less.

You could rent it above $1K/month, which leads to the same objection. As a short-term agreement, renting is expensive and thus turns most people off.

What about leasing? You could ask for a $5K downpayment plus $1.5K for monthly rent. You offer a 3-year term.

This lowers the entry barrier, attracting both tenants and potential buyers. For them, this downpayment is lower than a mortgage, and in practice, it’s not that different from buying. They have three years to afford the house while paying $1.5K.

If they want or can afford it. Otherwise, they can walk away without obligations nor credit hits. And you made an extra $500.

If they cancel the lease for whatever reason, there’s a fee worth 2-3 months of rent. They’re unlikely to do so.

The benefit for the lessee is to keep the asset as if they owned it without having to buy it. In the case of vehicles, you can trade in and keep your equity the next time you finance.

How do you buy the $150K house first? A loan, for example. As long as your costs don’t go beyond $1500/mo.

Example: Leasing a car

Unless you’re planning to use it for 5+ years, buying a car is rarely a good idea. If you buy a new one, it devalues the moment you drive off the lot. And if you’re reselling an unreliable model, fewer people will accept your offer.

If you don’t want to be stuck, it’s better to lease for the chance of trading in cars. At least, you can leave without purchase obligation.

Compared to renting, leasing is cheaper long-term, except when you want to resell the car.

If you keep a vehicle for 5+ years, it won’t be long before you have to deal with car repair problems. Why not switch to another model?

When your lease term ends, you can apply the equity you created to a new car purchase or lease. So if your car’s residual value is $10K and your lease contract was $8K, that $2K applies for your next deal. You can buy any car brand you want.

Although it depends on your strategy, the best way to save on vehicles is to use, not own. Unlike properties, cars devalue and don’t make you money (except for commercial uses).

To Get A Lease Or Loan?

To Get A Lease Or A Loan

Now, let’s address the major differences between leases and loans.

Applications

If you get a personal loan, there are multiple ways to spend it. But if you want to diversify with a lease, you’ll have to create a contract for every asset you want, (unless you’re leasing everything from the same company).

While borrowers prefer flexibility, lenders consider it less reliable. It’s easier to get a lease or dedicated loan (mortgage, student loan, car loan…) than a personal or business loan.

Ownership

Both loans and leases are financing strategies to gain ownership. If you can’t afford it, you can borrow it to buy it today. Or you can use it with a lease to postpone a possible purchase.

If you borrow, you have to pay back the interest, or the loan affects your credit score. If you lease, you pay the monthly rent, or the owner repossesses the asset.

Should you borrow to own today or lease to own later? If you believe you can earn more, it’s better to lease to save money, which you could invest somewhere. Whether you pay a downpayment or not, that affects your rent.

Asset Value

When you lease a car, the offer depends on the purchase price. When the term ends, the car’s value depends on its condition. Small damages reduce its trade-in value. If they are severe, you may face a penalty fee.

But you can still trade your vehicle. If you bought it with a loan instead, you’d be stuck trying to sell it.

Why lease? Because if it devalues, you don’t want to be stuck with it. On the flip side, leases require full risk insurance and inspections.

What about properties? You don’t own it until you buy it. And even though you may rent to own, you risk that it appreciates, costing you more on the purchase. Unless you can fix the purchase price, it’s better to buy it with a loan.

Following this logic, leases seem to work better with assets that may devalue, while loans serve for the opposite.

Convenience

The terms of your loan depend on your credit score. And if it’s less than ideal, you’re overpaying.

If you lease, you can buy it years later, which is enough time to raise your score. So if you don’t earn enough to own the asset, at least you can get a loan with better rates.

Taking a loan itself lowers your score for 12 months because it’s considered a hard inquiry. Leasing, however, has no impact on your score. And instead of requiring the bank’s approval, you negotiate a lease with the owner.

At the end of the contract, everything you’ve paid may discount on your purchase. Which makes it better than renting.

Leasing is expensive if you return the asset. And it also has to be in the original condition. So if you buy and improve a property, you will need to either buy it or undo the changes.

Loans don’t have that problem.

The Bottom Line

The Bottom Line

For those who can’t afford big down payments, leasing makes sense. While spending more than on rent, you’re also buying time to afford that house or car. Time to raise your credit score and pay even less.

You will always get the best rates when you pay high upfront. And the more you’re willing to do so, the more payment options you have.

Whatever saving strategy you prefer, you need to equally prioritize your repayment plan. While one strategy may be better than the other, it’s not going to pay off itself.

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