You don’t have to be a car enthusiast to be excited about getting a new car. It’s time to get the latest features, or one with better gas mileage, or just one that has more space for your growing family. There’s a lot of decisions involving it too.
Do you get a used or new car? An SUV or sedan? Do you want a Kia or Chevy? Another big decision you have to make is buying a car vs leasing.
Buying a car is usually more economical and you get to own it after paying it off. But if you prefer swapping out cars more often or want lower monthly payments, then it might make sense to lease.
Let’s look at all the sides to the question of whether to buy or lease a car. Then, you’ll be able to make the right decision for you before heading to the dealership.
What Does Leasing a Car Mean?
You can think of leasing a car as similar to your monthly subscription to a streaming service like Netflix. You have access to Netflix and all their shows and movies. However you don’t actually own any of the content so once your subscription ends, so does your access to it.
When you are leasing a car, you are renting that car for a certain period. You pay a monthly amount that includes interest and fees.
Depreciation, which is the amount that the car’s value is expected to decrease over that time period, is also added to this monthly payment. In almost all car leases, the value of the car at the end of the lease is determined before you leave the dealership. This type of lease is called a closed-end lease.
In most cases, there’s a down payment that must be paid up-front on the leased car. The rest of the cost of the lease plus interest and other fees are divided into the monthly payments for the term. Most lease terms are for two or three years but some are longer.
When you’re considering leasing a car, there are some different phrases that are used which you will want to be familiar with. These phrases aren’t used when you’re buying a car. Here’s what you’ll want to know when considering a lease on a car:
This is the price of the car, which is also called “Cap Cost”. Similar to when you buying a car, you should try to get the lowest price possible on the capitalized cost of a leased car.
This cost is generally fixed with lease deals that are automotive-sponsored, but if it’s not, then you should haggle down this price. Cap cost reductions refer to discounts on the capitalized cost. You find these in special lease deals that automakers promote.
Instead of using an interest rate to represent the amount of interest that is part of each monthly payment, leasing companies use the term money factor.
To convert the money factor to the annual percentage rate (APR), you multiply the money factor by 2,400. Other names for the money factor include “lease fee” and “lease factor”.
You may have noticed that cars depreciate at different rates. Cars that hold their value over time better will have higher residual values. A lease on these types of cars will generally offer a better deal.
What is Financing a Car? (Buying)
Now that you have a grasp on leasing a car, let’s move on to car buying and financing. Although a record number of people totaling 4.3 million Americans according to Emunds are leasing, buying a car is still the most popular route to take when getting a new set of wheels.
When buying a car, you have the opportunity to negotiate the price. Unless you can afford to pay the full price of the car, you take out a car loan to cover the cost. You can pay a down payment or offer a trade-in and finance the rest of the car purchase.
For example, let’s say you want to purchase a $35,000 car. Your trade-in value for your existing car is $5,000 and you will put down an additional $4,000 as a down payment. The $26,000 remaining will be financed as a car loan, plus the cost of interest.
The title for the car is held by the lender when you use financing for the purchase. Once the loan is paid off, the title is released to the borrower. If you paid up-front for the full cost of the car, you own the title after completing the purchase.
To finance a car, you can go to a bank, credit union, or finance company. It’s common that a dealership works with several financial institutions that allow you to pick the best terms offered.
Once you apply and are approved for a car loan, the money for the car is sent by the lender. The principal is the amount that is loaned to you for the purchase. This amount plus the interest on the loan is divided into equal monthly payments based on the term.
The term is the amount of time that the auto loan is for. This term generally varies from a few years to six or seven. The longer the term, the lower the monthly payment will be and the more interest that is paid on the loan.
A long-term auto loan is a loan that is six or more years long. This lengthy period is usually outside the warranty coverage period which means you risk the potential of making a car payment and paying for repairs at once. That is why it’s best to keep the auto loan term to five years or less.
Advantages of Leasing a Car
There are advantages to leasing a car that could be a potential benefit of leasing a car over buying. Here’s what you should consider:
Lower down payment
Lower monthly payments
Same as above, when comparing buying versus leasing a car, the monthly payments tend to be lower on a lease.
Since lease terms tend to be for a few years, the factory warranty will usually cover you for the time that you have the car. So that means that other than regular oil changes, you won’t have to worry about spending money on costly maintenance.
Sales tax savings
You can possibly save money on sales tax when choosing to lease a car. The actual savings will vary and depend on where you live on the tax policy. In some places you may only be required to pay the sales tax for the down payment and all the monthly lease payments.
However in other places you could be required to pay sales tax on the entire price of the car. In those cases, its exactly the same as if you purchased the car and there’s no additional benefit.
If you trade-in your car towards the new lease, it’s the same case. In some places the trade-in value is deducted from the purchase price of the car while other areas you won’t get this credit. For specific tax information in your area, talk to a tax professional.
Take advantage of new technology
When you buy a car, you're likely going to be stuck waiting a several years or more before you can get a car with those features. With leasing, every time you trade-in the car for a new one, there’s the opportunity to have that technology. Additionally you could afford to get a more expensive car model that you otherwise couldn’t with buying a car.
Trade-in process is easy
After a car lease ends you take the car back to the dealership you got it from. Sometimes you may have to return it to another dealership that’s franchised with the same car brand.
The car’s condition will be checked as well as the mileage. If there’s damage or you went over your mileage allowance, there’s some fees that you might have to pay. And of course, there’s some paperwork involved.
But otherwise, it’s a simple process. Since you’re returning a leased car, it’s likely that you will leave the dealership with a new lease on a new car.
Advantages of Buying a Car
Buying a car also has its advantages. Some of these pros include:
The car is yours
There’s two ways that owning a car happens. You can pay for the car outright which allows you to own it immediately. The more common way is taking out a car loan.
Once you’ve paid off the loan, the lender will release the car title to you. Even while you’re paying off the car, you’re able to do whatever you want to the car. There’s no restrictions on what can and can’t be done to the car.
You don’t have a mileage cap
A car lease requires that you agree to a mileage cap that if exceeded means that you will pay extra charges. When you buy a car, you can drive it as much or as little as you want.
You’re free to take it on a road trip from one coast to the other without worrying about paying for mileage. If you drive a lot or have a long commute, buying a car is usually a better route to take.
Car payments end when your loan is paid
After you make your final car payment, there’s no more that you have to budget for. This is one of the bigget reasons for chosing to buy a car over leasing.
Let’s say you have a four year loan on a truck. You end up keeping it for nine years before getting a new one. That’s five years of being free from a monthly car payment.
A great strategy that can be used by car buyers is to use that free time to save up for their car. Those extra funds can be put away in a savings account which can be used to make a big down payment. Or if you have an expensive repair that needs to be done for the current car, those reserves can be used to fund it.
You have money to put down towards your next car
You can either sell the car to a private-party or trade it in to get money for it. In turn, that money can be used for the new car. You don’t have a car to sell back with a lease since you don’t own it.
Here’s an example to show you how it works: You have a $35,000 sedan which is six years old that you’ve paid off the loan on. It’s now worth $15,000 which you get by selling it to a private-party. Now you have $12,000 that can be used on your next sedan or type of car you wish to buy.
It’s important to remember that you get the best value selling a car on your own over trading it into the dealership. Of course, many people choose to trade their car in because of the convenience of being able to buy their new car at the same time when at the dealership.
Getting financing is easier
A car loan typically have lower credit score requirements than for a lease. A borrower that may not have the best credit can still qualify, though likely pay a higher interest rate. However, they will be more likely to find options for financing than leasing opportunities.
The process of getting a car loan is usually more familiar too. Borrowers can usually find loan applications online from lenders. There’s also websites that allow you to get several quotes with one application.
Dealerships have relationships with lenders and may be able to find you a good deal as well. However, it’s best to come into the dealership with a pre-approved financing offer that you can compare it to. That will give the dealer more incentive to work harder to get your business.
Can refinance a car loan later
The monthly payments on a lease are set in stone before you drive out of the dealership. But when you’re financing a car, there’s the option of refinancing the loan down the road.
By refinancing, you could take advantage of a lower interest rate and monthly payments. The term of the loan can also be changed. Reducing the length of the loan could save you interest charges. But lengthening your loan is not a good idea since it has the opposite effect of more interest.
For borrowers who purchased the car initially with less than ideal credit and have boosted their credit score can benefit from refinancing.
Disadvantages of Leasing a Car
The benefits of leasing might not make sense for everyone. There’s also some downsides that you may not be aware of. Before you lock yourself into a lease, take a look at these considerations below.
You don’t own the car
The leasing company will hold the title of the car the entire time you are leasing it. Since you don’t own it, you have to follow someone else’s rules.
You aren't allowed to customize the car like putting in a third party stereo system or getting different rims. In some cases, you may even have to get permission to drive it certain places like Mexico. Breaking one of the rules of the lease agreement could lead to the car being repossessed.
The insurance payments for a stolen or totaled car will go to the leasing company. It doesn’t matter how much money you’ve paid into your lease, you will have to get a new lease in these cases.
The allowable mileage is limited
There’s really no exception to this rule that a car lease has limits on the number of miles you can drive it. Once you’ve gone over this mileage cap, the cost adds up fast.
The cost generally ranges from 15 to 40 cents for every mile over the cap. Let’s say that you drive about 30 miles per day and are over your limit. The means it could cost you $4.50 to $12 everyday.
The leasing company and type of car you lease determines the actual amount. The annual mileage limit is normally shown in advertisements. You typically won’t have to get your mileage checked each year to verify that you’re under the limit.
Lease companies will do this at the end of your lease when you turn your car in. They will take the annual mileage and multiple it by the number of years in the lease to calculate the total mileage cap.
For example, a leased car could have a limit of 12,000 miles per year. Multiplying that mileage by the lease term of four years equals 48,000 total miles. That’s the maximium mileage you can have before paying additional charges for every mile over that.
Those who don’t know how many miles they drive every month could be taking a risk with getting a lease. You have to have a good estimate of how many miles you drive before getting a lease. There’s not only the risk of going over the mileage limit and paying extra charges.
If you drive far less miles than the allowance, it ends up being a waste of money. The price you pay for the lease includes expected number of miles that you will drive. So you end up paying for miles that weren’t driven.
A never-ending car payment
Leasing a car puts you in a cycle of leasing one car to another each time a lease term ends. Leaving room for making a car payment every month can get difficult if an unexpected expense throws off your finances.
When financing a car for purchase, once your loan is paid off you are done. The monthly payments on a car loan are also typically more consistent. That’s because each time you get a new lease on a car every few years, the price of the car is likely to rise leading to a higher lease payment than the previous.
You don’t get money to go towards your next car
At the end of your car lease, you will most likely be paying extra to cover additional mileage, disposition fees, or other charges. Therefore to pay for your next lease, you only have your wallet as a source of funds.
There are some zero-down lease deals that are offered by manufacturers. But they aren’t common so you can’t depend on one being available when your lease ends.
Disadvantages of Buying a Car
There are some drawbacks to buying a car too. You should know about the following:
In the short term, buying is more expensive
The monthly lease payments on the same car is usually less than the monthly payments on a car loan. It only gets cheaper once you’ve paid off the car loan.
You are able to manage your monthly car payment if you have available cash. Making a large down payment is one of the best ways to do this. Put together a savings plan to go towards a new car. The earlier you do it, the better since you’ll be able to save more over a longer timeframe.
You’ll pay more interest when buying a car
The entire cost of the car, less your trade-in and down payment is the amount you will pay interest on. The interest that you pay on a lease is only on the depreciation that’s expected during the lease.
You will probably own the car longer than the warranty lasts
The car warranties that come with new cars are long enough to cover most new car leases. But when you own a car, it’s most likely that you will have it for longer than that.
Once you’re out of the warranty period, you have the risk of having to cover any necessary repairs. Paying for out-of-warranty repairs is expensive.
One way to reduce your risk is to take a look at reliability scores of different car models. Cars that are rated higher for reliability have a better chance of not running into mechanical problems.
Some car manufacturers offer longer warranty coverage for certain cars. For example, all Kia models come with a 10 year or 100,000 powertrain coverage.
You don’t know what the car will be worth down the road
There’s some assumptions that you can make to predict what a car could be worth in five, seven, or ten years. However an estimate is just that and it may end up not being accurate.
The condition, miles driven, and other factors can affect the value by thousands of dollars. That makes it hard to know what to budget for your next car.
Important Costs to Consider When Deciding to Lease or Buy a Car
Make sure you know all the costs involved with leasing and buying. You should run the numbers to make sure that you can afford whichever route you take. Here are some costs that you should account for below.
You have your monthly payments on a car lease or finance. Monthly lease payments are usually lower than car loan payments. This is since lease payments are based on the car’s depreciation for the time that you’re leasing it versus it’s purchase price.
Car insurance is required whether you lease or finance a car. Depending on the insurance requirements, you may have to get both comprehensive and collision coverage.
Gap insurance might be a good idea particularly if you opt to lease a car. It covers the loss of your car in case of theft or an accident. In most cases, you’ll still have to pay off the rest of the lease or loan. It covers the difference between what you still owe on the car and what it’s worth, minimizing your loss.
The down payment for a financing a car is usually around 10 or 20 percent of the total price. Your credit score and other factors may also affect the actual required down payment. For instance, borrowers will lower credit scores may have to pay a bigger down payment to get approved for financing a more expensive car.
If you decide to lease, we prepared to pay some upfront costs. This could include a down payment and the first month’s payment.
The cost of repairs is another factor that affects both lessees and car buyers. When you have a long commute or live in a place with poor road conditions, there’s more wear and tear on the car.
You might be required to pay for maintenance or repairs when leasing since you have to keep the car in good condition. Since those who buy a car tend to keep it longer, the cost of repairs rises as the car gets older. Car buyers may consider putting aside funds for handling this type of upkeep.
There are some unique fees when it comes to leasing that you should know about if you decide to lease a car. They include:
• Acquisition fee - Administrative costs of the leasing company to arrange the car lease.
• Disposition fee - Cleaning and selling costs for the leasing company at the end of your lease.
• Early termination fee- If you end the lease contract early, this is a fee that you could be charged for doing so.
• Security deposit - Usually this amount is roughly one month’s lease payment.
Car Loan vs Lease Example
Let’s look at a side by side example of a car loan vs lease. The example is based on a $30,000 SUV.
$500 (Security Deposit)
Sales Tax Rate
Cost of Car
To determine whether to buy or lease a car, it’s important to understand all the costs involved and how each option can affect your finances. There’s also important factors to consider like how important it is to have the latest technology and how much driving you do. Make the decision based on what’s most important to you that you can financially afford.
About the Author
Anjana Paul is a banking professional who is passionate about helping others make better choices when it comes to money. In her spare time she is a freelance writer with years of expertise in the financial industry. She primarily writes about topics such as student loans, building credit, budgeting, retirement and other personal finance topics.