It's a common dilemma: lease or buy, buy or lease, which is better?. Everyone who has ever considered leasing has had this question cross their mind. So what is the answer?

It depends

Leases and loans are simply two different methods of automobile financing. One finances the use of a vehicle; the other finances the purchase of a vehicle. Each has its own benefits and drawbacks.

It's not possible to simply say that one is always better than the other because, well, it depends on your own particular situation and preferences.

You must not only look at the financial comparisons but also at your own personal priorities — what's important to you.

Is having a new vehicle every two or three years with no major repair risks more important than long-term cost? Are long term cost savings more important than lower monthly payments? Is ownership more important than low up-front costs and no down payment?

So, making the lease or buy decision is not quite cut and dry. There are some things you need to know first.

Buying and leasing are different

When you buy, you pay for the entire cost of a vehicle, 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. You make your first payment a month after you sign your contract.

When you lease, you pay for only a portion of the vehicle'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 pay a money factor that is similar to the interest rate on a loan. With leases, you may also pay extra 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.

Buy vs lease example

As an example, if you lease a car that costs $20,000, but is worth only $13,000 after 24 months, you pay for the $7000 difference (this is called depreciation), plus finance charges, plus fees.

When you buy, you pay the entire $20,000, plus finance charges, plus fees.

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. 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.

Loan payments also have two parts: a principal charge and a finance charge, similar to lease payments. The principal pays off the 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 principle 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.

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.

Buy or lease - Savings account or no savings account

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 portion of every payment you make is lost to depreciation. What you have "to show" for your investment when your loan is paid off is only what is left over after depreciation. A terrible investment by any measure.

Leasing, then, is similar to buying, but without the "savings account." You only pay for what you use. It's true that you'll own nothing at the end of a lease; you have nothing "to show" for the money you've put into it. 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 rent or buying groceries.