August 31, 2020

Leasing vs Renting: Everything You Need to Know

Leasing and renting are similar concepts, but can have very different financial impacts. What are these impacts, and which is right for you?

By
Mack Grenfell

If you're looking for somewhere to move into, but aren't loowking to buy, there are two terms that you'll quickly come across; Leasing and Renting.

These two terms have similar meanings, but can have very different financial implications. You'll want to make sure that you understand these implications before you make any decisions about where you want to move to.

What's the difference between leasing and renting?

At a fundamental level, leasing and renting are fairly similar. They both involve an agreement to pay a landlord a fixed monthly sum in order to live in a property. Where they differ is in the length of the agreement.

What does it mean to rent?

A rental agreement typically lasts one month at a time; you pay your landlord a monthly rent, and in return you're allowed to live in the property for the next month. Usually the rental agreement will roll over into the following month, and so on.

The crucial point to understand here is that the landlord has the ability to change the terms of the rental agreement every month, and with that the ability to change the price that you pay. If your landlord wants to increase the rent each month, then there's nothing that you can do to stop them (other than find another place to stay).

What does it mean to lease?

In contrast to this, a lease agreement will last for a longer, fixed period of time. The usual length of a lease agreement is 12 months, but it's not uncommon to see 6, 18, or even 24 month lease agreements.

What this means is that, in the case of a 12 month lease agreement, the rent you pay will be locked in for the next 12 months. The rent is usually still paid on a monthly basis, but the landlord doesn't have the ability to change the amount until the end of the agreement.

Once the lease agreement comes to an end, the tenant normally won't have any option to automatically extend the lease, and the landlord may choose to increase their rates.

Should you lease or rent?

We saw above that the main difference between leasing and renting is the length of the agreement. In a rental agreement, both the landlord and tenant have the ability to terminate the agreement with a month's notice, whereas in the case of leasing, both parties will have to wait until the lease expires.

One of the most important factors therefore in deciding whether to lease or rent a property is how long you plan to stay in that property for.

When does it pay to lease?

If you have plans to settle down for at least a year, then leasing can often present a better choice:

The only downside of leasing is the lack of flexibility.

If you're not sure whether you're going to be living somewhere for the duration of the lease, then leasing becomes a much less attractive option. If there's even a small chance that you might have to move out before the end of the lease, then renting could be a much more sensible route.

When does it pay to rent?

To understand when renting is a more attractive option, let's consider an example.

Let's say you're weighing up a 12 month lease and a monthly rental, both at $1,000 a month, in a particular city.

We'll assume that there's a small, 10% chance that you'd have to move away from this city 9 months in, and that if you moved you'd have to spend the same amount ($1,000) on rent wherever you moved to.

If you go for the rental option, your rental costs are going to be $12,000 for the next 12 months, regardless of whether you move or not. This is because you can terminate the rental agreement as soon as you know you're going to move, and start your new rental agreement once you move.

If you choose to lease, then you're going to be paying a minimum of $12,000 in charges for the next 12 months. There's a 10% chance you'll need to move 9 months in, which means that there's a 10% chance of you paying double rent for the last 3 months.

Effectively this means that there's a 10% chance of you having to pay an extra $3,000; equivalent to saying that there's an additional expected cost of $300 associated with leasing.

This gives the lease agreement an expected total cost of $12,300, $300 more than if you were renting.

Of course, this $300 difference grows even larger if you're more than 10% likely to move before the end of your lease, or if you'd need to move earlier on in your lease.

What if rents rise?

In the example above, we've assumed that the cost of a rental agreement would stay fixed over 12 months. In the real world though, this assumption might not prove true.

Let's extend our example by considering the chance that rents might rise within the next 12 months. Our assumptions will be:

Suddenly, as we try to account for the possibility of rents rising, our decision becomes much more complex.

Leasing vs renting: an interactive calculator

To help answer what you should do in a situation like this, we've put together an interactive calculator below. The model lets you compare two scenarios (renting and leasing) under all the circumstances we've looked at above.

Have a look at the inputs on the top row, and customise them to suit your situation. Notice how the calculator's outputs change as you do so.

Once you've had a go at changing the inputs, click Use this template in the top right, and you'll be able to customise the calculator further.

While you're here...
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