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What’s best for you? Car lease or car loan?

Posted on 12 May 2016

Is it better to lease or buy your next car? We take a look at how both types of finance work and explore the benefits and negatives of both.

If you’ve decided you need a new car, you will need to work out how you’re going to finance your purchase. You may be lucky to have enough cash in the bank to make it possible to buy your car without requiring a loan or a lease. But if you don’t have access to sufficient funds, you need to choose the best financial set up for your needs.

What are your options?

There are two different directions you can go in to get hold of your car. You can choose to lease a car, or you can take out a car loan. It can be difficult to work out which option will suit you best, but there are some key differences that could help you make a decision.

How does a car lease agreement work?

A car lease allows you to access a new car without actually owning it. Firstly, you decide which make and model you would like, and then you choose a lease period for your agreement. This is usually between two and five years.

When the lease agreement is set up, the expected depreciation of the car over the duration of your lease is calculated. Your monthly instalments are then calculated to cover the cost of depreciation - effectively like a loan for that amount - plus additional fees related to cost and profit.

You will have to pay some upfront costs when you set up the agreement, including a refundable security deposit; taxes; registration and insurance. Insurance costs can be higher for lease vehicles. Your agreement will also place some restrictions on the use of the car, especially around what’s deemed reasonable wear and tear, and the permitted annual mileage.

At the end of the lease agreement you return the car to the dealer and pay any closing charges. If you have exceeded your mileage or there is any damage to the car you will also be charged for these.

With a closed-end lease agreement the depreciation is agreed at the start of the lease period so there should be no additional costs when it ends. If, however, you have an open-ended lease agreement the leasing company could calculate that the car value has actually depreciated further than expected and you may be required to make an additional one-off payment to correct the balance.

Who does a car lease work well for?

In the longer term - over 10 years - a car lease actually works out more expensive than a car loan, due to the repeated set-up and completion costs. And of course you don’t come away with a car at the end of the agreement. You also face early termination charges if you try to finish the agreement before its end date, and suffer the restrictions in mileage, and personalisation or customisation of the car. 

Aside from the financial negatives, a lease agreement can offer an excellent way to access a high value, new model or make of car that you couldn’t otherwise afford. Leasing makes it easy to change your car every few years and always have the latest model.

Because you are only paying for the depreciation of the car, not the full value, your monthly payments are lower than they would be if you bought the same model. If you need a luxury vehicle for work purposes, you could also experience tax benefits from a leasing arrangement.

How does a car loan work?

A car loan allows you to buy the car of your choice. You decide on the make and model, and then contact a loan company to organise your finance. A good car loan is a balance of recognising what you can afford to pay and trying to pay your loan off as quickly as possible. 

Your loan company will set up regular repayments for set amounts, and will charge you interest based on the outstanding balance of your loan. You can pay a deposit upfront to reduce the size and cost of your loan. Most loan companies charge set-up fees, and you will have to manage the upfront costs of ownership such as insurance, registration etc.

When you’ve paid off your loan and the agreement ends, you’re left as the owner of your car. You can then continue to drive the car with no loan repayments until you decide to sell it, when you can use the equity that you've generated as a deposit for your next car.

Who does a car loan work well for?

A car loan potentially costs more to manage in payments as it covers the full value of the car, minus any deposit. But you do own the car at the end of the agreement. 

There is a risk with a car loan that if you sell the car before the loan is paid off you may not get enough money back to cover the outstanding loan balance. For this reason, loan companies often recommend adapting loan duration to be within the likely ownership period.

Using a car loan gives you total control over how you use your car. If you wish to customise or modify it in anyway there are no restrictions, and you can also clock up as many kilometres as you wish to.

Depending on the loan agreement you set up you may find yourself limited in flexibility if you choose to increase your repayments or try to reduce the duration of the loan. We recommend you speak to someone on our team about options for your loan - we can help you set a realistic budget and adapt your loan to changing circumstances. 

Choosing between a car loan and a lease agreement on a financial basis is easy. While the payments for a loan are usually higher in the short term, a lease usually works out more expensive in the longer term and you don’t come away with ownership of a car.

But on a more emotional level there are many reasons why a lease agreement could be preferable. It’s easy to change cars at the end of each lease period and the car you choose can be newer and of a higher value.

However if you’re entering into a financial agreement because you want to own a car, then a car loan is what you need. Car loans can be structured to suit your circumstances, and ultimately allow you to build up equity in the vehicle that you have chosen. If you’re interested in exploring your options, contact the Online Car Loans team today and find out how we can get you on the road with the right car loan for you.