Aside from choosing a vehicle, whether to lease or buy is perhaps your biggest car-buying decision. We lay out the costs and benefits of each below.
While it’s always sound advice to pay cash for your next car purchase with the average used car nearing $30,000 dollars and new cars going for over $40,000, most of us will need to either lease or finance our next vehicle purchase. Leasing can be an enticing option. The allure of a new car at a relatively low monthly payment can sway even the most frugally minded. And yet, buying a vehicle outright can often be the better financial decision over the long haul.
Below, we walk you through the basics of leasing vs buying a car, lay out the pros and cons of each, and offer some practical takeaways to consider for your next vehicle.
Leasing versus buying a car is directly analogous to renting one over an extended period of time. Most leases start with a down payment. This is often lower than the down payment you’d make when financing a vehicle. The same is true of the monthly payments. After a set period of months, most typically three years, you return the vehicle to the dealer.
The basic math on a lease works out as follows. First, there’s the capitalized cost or, in other words, the total value of the vehicle. Then there’s the residual value, the estimated value of the vehicle after depreciation. The difference between the capitalized cost (initial value) and the residual value is what gets divided into your 36 payments. Additionally, there are fees, taxes, and the “money factor,” which is fancy dealer speak for interest, that all get tacked on. Financial guru Dave Ramsey estimates the interest rate to run an average of 14 percent on a car lease. That’s significantly higher than the interest on a traditional car loan.
At the end of a lease you return the vehicle to the dealer and start looking for your next one. Often dealers will offer a lease-to-buy option allowing you to purchase the vehicle once the lease term is up. You’ll have to compare the residual value of the vehicle against the current market to evaluate whether buying your leased vehicle is a good deal.
Though you may end up spending more in the long run (which we’ll get to in a moment), leasing can be an attractive option for those looking to keep their initial costs low. Typically, a lease has a lower down payment or none at all, lower monthly payments, and lower taxes as most localities only charge sales tax on the down payment of a lease (this varies from place to place, however). Lease deals often come with their own special incentives that can make them even more enticing. There are also tax incentives for businesses then they lease a vehicle rather than buy one.
Another big reason people lease is they like to change cars every few years and want to be in the latest and greatest new car as often as they can. Leasing a new car and returning it in a few years for another lease can be the perfect antidote to automotive malaise.
Leasing versus buying can also alleviate a lot of car owning headaches. Usually a lease will be under manufacturer warranty (and new besides) and any repairs outside of an accident should be covered. There’s also none of the hassles of trading in or reselling the vehicle like there is when you purchase it.
The chief downside of leasing is financial in nature. Since you’re basically renting the vehicle, at the end of the lease term you’ve got to give back the vehicle. The math may work out over the first three years that a lease is cheaper than buying a vehicle, but you’re also never building equity with those payments. At the end of the lease term, you’re back to looking for a new whip. Chaining lease to lease means perpetual car payments.
Lease agreements carry myriad stipulations covering things like wear-and-tear charges and early termination fees. Since the dealer will be planning to resell your leased vehicle, they will want it back in the best condition possible. This means “excessive” wear-and-tear or other damage to the vehicle will be charged to you when you return the vehicle. If you decide you don’t like the vehicle, you may also find it difficult to get out of your lease without paying hefty fees to do so.
Lease agreements also stipulate how many miles a car can be driven each year or in full without being charged extra. Those limits usually run anywhere from 8,000-15,000 per year (with 12,500 being the average). Overage charges are usually assessed by the mile at a rate anywhere from 10-40 cents per mile.
Since you won’t be owning the vehicle at the end of the lease term, you won’t be able to customize your ride either. No spoilers, window tints, or lift kits.
All those attractive lease offers you see advertised are only available to those with sterling credit scores. If your credit is less than perfect, expect those lease payments to more closely resemble those of a financing deal.
As we said at the outset, it’s always wisest to pay for a vehicle in cash when you can. The next best option, over the long term, is to finance a vehicle while making every attempt to pay off the loan early. At then end of the loan term, the lender signs over the title to you and you own the vehicle. Despite being a depreciating asset, a vehicle is still an asset. That is, it can provide equity that a lease cannot.
Though a vehicle depreciates over time, when you finance or otherwise purchase a vehicle you build positive equity, meaning you’ll have something of value once the loan term is up. You can either roll that positive equity into your next purchase with a trade-in or just enjoy the financial freedom of not having a car payment.
While the monthly payments may be higher than a lease, buying a vehicle, whether financed or bought in cash, will be cheaper over the long term thanks to that positive equity. Additionally, almost all leases are for new vehicles. This sets a minimum threshold for payments that you don’t find on the used car market.
Outside of a manufacturer or extended warranty, you’ll be responsible for mechanical repairs on your purchase. That’s may be fine for those shade tree mechanics among you, but for those less thusly inclined, repair bills can be a big headache of car ownership.
Dealers and lenders have been offering longer and longer loan terms, now up to 72 and even 84 months in length, which may keep down your payments but at the cost of additional interest over time. Long term loans also increase the likelihood of you getting “underwater” on your loan, that is owning more on the loan than the car is worth, if the depreciation rate outstrips your rate of payment. This can be especially burdensome if you get into an accident where the vehicle is totaled and the insurance pays you the value, which is now less than what you owe on the vehicle. This is another reason to always focus on the purchase price rather than the monthly payment when you’re car buying.
Cars depreciate in value over time. When you’re purchasing a vehicle, you’ve got to be okay knowing your vehicle will be worth less tomorrow than it is today. This is why we recommend buying cars with high levels of reliability and low depreciation rates.
When considering whether leasing versus buying a car is best, consider the following questions:
How long do you want to keep your vehicle? If you’re in love with only the newest and shiniest of cars, leasing can be just the ticket.
Do you want to customize your car? For true enthusiasts, purchasing a car is often the only way to go.
How will I be using this vehicle? If you’re carting around a bunch of young kids prone to spilling Shake Shack all over the upholstery or looking to do some less-than-light off-roading on the weekends, leasing probably isn’t for you. Same goes for those looking to put serious miles on their vehicle.
And finally, is always driving something new worth the extra expense over time? If you want to drive the latest and greatest cars out there and don’t want the hassles of reselling or taking a hit on depreciation, leasing might be a reasonable choice. On the other hand, if you like to keep your vehicles a long time and thereby save money over the long haul, the financially prudent choice is to purchase your next vehicle.