How do loans and leases differ?

Is it better to lease or buy? 

When you take out a loan, all of the money used to pay it off applies to your eventual ownership of the vehicle. The initial down payment and principal on the loan cover the total cost of the purchase.

Lease payments, however, apply only to the use of the vehicle. The total sum of payments covers the vehicle's depreciation over the time you drive it and is usually less than the outright price of the vehicle.

When is ownership transferred?

When paid in full, a loan terminates and you assume ownership. Your bank sends you the title that had been held while the loan maintained an outstanding balance.

When a lease period ends you forfeit the vehicle to the lessor, unless the lessor offers to sell the vehicle afterwards. During the entire lease period the lessor maintains ownership and simply allows you to use the car. Ownership is only transferred if you chose to buy the vehicle after the lease terminates.

How are monthly lease rates determined?

In formulating a monthly payment structure, a lessor is primarily concerned with the extent to which the vehicle will depreciate throughout the lease and the cost of borrowing money to finance the car during that period.

Three key elements:

• First, the adjusted capitalized cost is determined. This figure represents the real purchase price after elements such as the down payment, incentive discount and trade-in credit are deducted from the capitalized (actual) cost, while any fees or charges (e.g. destination) are added.

• Second, the residual value, or estimated value of the vehicle at the end of the lease, is determined and then subtracted from the adjusted capitalized cost to yield a depreciation figure. The residual value depends on the length of the agreement, expected mileage and make/model of the vehicle.

• Finally, a lessor assesses the money factor, a number that correlates with the cost of borrowing money during the lease period.

While these terms may seem unfamiliar, the Federal Reserve Board now requires dealers to publicize all leases' down payment amounts, lengths, residual values and interest rates.

What factors determine the purchase price at the end of a lease?

Most leases rely exclusively on the residual value in determining the end of term purchase price. These closed-end deals require you to pay the fixed residual amount regardless of the actual market price.

Open-end leases work differently in that the actual market value helps determine the purchase price. As a customer you are responsible for any difference between the residual and actual value when buying outright.