How car leasing works

What car leasing is

Car leasing, or locação financeira in Portugal¹, is a contract where a leasing company buys the car you choose and rents it to you for a term, in exchange for a monthly rent. During the contract, the car belongs to the leasing company; it is, therefore, a rental with a buy-out option.

At the end of the term you have a decision to make: you can exercise the buy-out option (pay the residual value) and keep the car, or hand it back. It is this buy-out at the end that sets leasing apart from similar products.

The rent, the down payment and the residual value

Three values shape a leasing rent:

• The initial down payment is what you pay up front. It reduces the amount financed and, with it, the rent.
• The monthly rent is fixed and amortises the financed amount down to the residual value, on the "French" system (each rent covers that month’s interest and repays the rest).
• The residual value is the buy-out kept until the end, usually quoted as a percentage of the vehicle value.

The residual value is the lever that confuses people most. The higher it is, the lower the monthly rent, because the rent only amortises the difference. But it is a value you must pay at the end to keep the car, and it raises the total interest, because the capital stays outstanding for longer. You can see the effect of each value on the car leasing calculator.

Buy or return at the end

Because leasing is a rental with a buy-out option, there are two scenarios at the end of the contract:

• Keep the car: you pay the residual value (the buy-out). The total you paid is the down payment plus the rents plus the residual value.
• Return the car: you do not pay the buy-out. The total is the down payment plus the rents, and you keep nothing.

The difference between the two totals is exactly the residual value. That is why it is worth deciding, right at the start, whether you intend to keep the car: if so, a high residual defers the effort but does not remove it.

The VAT on leasing

There is a detail that changes the maths and that many people overlook: the rents of a leasing and the buy-out are subject to VAT at the standard rate (23% on the mainland)². For a passenger car, that VAT is generally not deductible for a private individual, so it is a real cost added to the rent. The interest on a car loan, by contrast, has no VAT.

So, when comparing a leasing rent with a loan payment, add the VAT to the rent first. The car leasing calculator shows the figures without VAT, to isolate the financing part; add the VAT to reach what you actually pay.

Leasing, car loan or renting

The three products all let you drive a car, but they are different:

• Car loan: the car is yours from the start (usually with the bank holding title until it is paid off) and it remains yours. See the car loan calculator.
• Leasing (locação financeira): a rental with a buy-out option. The car only becomes yours if you pay the residual value at the end.
• Renting (ALD, long-term rental): an operating rental that usually bundles services such as insurance, maintenance and assistance, with a higher rent, and that normally has no buy-out: at the end you return the car.

Whichever you choose, the fuel and the annual tax still weigh on the budget. For the cost of each trip, use the fuel cost calculator; for the leasing rent, the car leasing calculator.