The difference between loan and lease-to-own financing

The difference between loan and lease-to-own financing

Loans and leases enable customers to split a larger purchase into smaller manageable payments. While they serve a similar purpose, there are also some important differences that customers should understand.

Installment loans

How it works: With an installment loan, a borrower gets a lump sum upfront (called the principal), that they pay back to the lender in regular payments. In point-of-sale financing, the loan principal goes directly to the merchant to cover the cost of the purchase.

To pay back the loan, the borrower makes monthly payments over a finite number of months, such as 6, 12, 36, etc. There is a finance charge, expressed as an annual percentage rate (APR), which is based on the principal amount borrowed (the upfront amount borrowed) and added to the monthly payments.

Who it’s for: There are a wide range of loan options available for customers with excellent credit ("prime" loans) to non-prime credit ("second look" loans). However, customers with sub-prime credit or no credit may have a harder time getting approved.

1. Promotional interest periods: 0% interest, deferred interest, or no payment periods (where the interest still accrues but isn’t charged) are sometimes available and can help borrowers save.

2. Other borrower fees: There may be other borrower fees, such as an upfront fee or an early repayment fee.

3. Collateral requirements: If no collateral is required, the loan is considered “unsecured.” An example of a “secured” loan is a mortgage where a home is collateral if the mortgage isn’t paid. Point-of-sale financing is typically done with unsecured loans.

Leases (often called “lease-to-own")

A lease is a type of non-prime financing.

How it works: With a lease, a financing company purchases the item from the merchant, pays the merchant upfront, and leases the item to the customer over a fixed period. The customer still gets to use the item but doesn’t technically own it until they have made their last payment to the financing provider.

Instead of an APR, the customer pays the leasing cost, which is split into regular payments over a fixed period, such as 12, 18, or 24 months. This means the customer always knows the maximum amount they will have to pay, which gives them peace of mind.

Each fixed lease payment renews the lease-to-own contract. The customer can exercise an early purchase option to gain ownership of the leased item and save on financing costs. Customers can end their lease at any time by returning the item.

Who it’s for: Leases are a good fit for non-prime customers who are establishing or building their credit. Even customers without credit may get approved for a lease.

What to look for:

1. Early purchase options: Many providers will offer customers the ability to pay the original sticker price (in addition to other fees such as an upfront payment or early payment fee) to significantly save.

2. Credit reporting: Some leasing providers like Koalafi report payment progress to a credit bureau. On-time payments may give customers an opportunity to build their credit.¹

3. Other borrower fees: Borrowers may be charged other fees, such as an early repayment fee or an application fee.

4. Merchant fees: While it's a good idea to understand the merchant cost, lease options are typically more affordable for the merchant than loans. It's not uncommon for there to be no cost to the merchant to offer leases

While loans and leases are both means of paying for larger purchases over time there are some important differences to be aware of.

Regardless of the option, financing companies are required to be clear and upfront about all financing costs, and customers should read through all relevant documents before agreeing to a loan or a lease.

¹Customers may have an opportunity to build credit by making on-time payments over the entire agreement term. Koalafi reports positive and negative payment history to multiple credit bureaus.