Should you buy or lease your new car? That’s the eternal question confronting anyone in the market for a new vehicle. Figuring out how to pay is the least fun part of the car buying process. In addition to understanding how much vehicle you can afford in terms of a monthly payment, there are additional decisions to be made — like whether it’s more attractive to lease a new car or purchase it outright.
Understanding how car financing and leasing works, and the important differences between the two, is key to getting advantageous terms when you drive off the lot in a new car. If you’re confused as to which option might be the best for you, here’s a helpful breakdown.
Finance vs. Lease – An Overview
Financing versus leasing is an ongoing debate that is likely to continue for as long as each option is available to consumers. To be fair, there are pros and cons for each method of obtaining a new car, depending on your needs and individual situation.
Dealer (or bank) financing involves you paying back the whole cost of the vehicle to the dealership on a set payment schedule and at a set interest rate. You usually will make monthly payments over an extended period (five-to-eight years, normally) and for a fixed interest rate.
The upside of financing is that you will own the vehicle outright once it is paid off and that you will not be limited to driving a set amount of miles per year, which is a standard lease clause. However, for this to be an attractive option, the interest rate needs to be low – 3% or lower is recommended (0% interest rate, if you can find it, is obviously best).
With a lease, you essentially rent the car from the dealership for a set period. You make monthly payments to lease the car for 24, 36, or 48 months, but these payments are typically lower than if you were to buy the car outright. When the lease period ends, you return the car to the dealership and lease a newer model, or simply walk away altogether.
Leases are great for people who want low monthly payments, or who like to constantly drive new cars. People can return the car they have when the lease period ends and quickly get themselves into another new car, with all the latest bells and whistles. But a lease comes with a lot of restrictions and penalties.
Most lease agreements prevent people from driving more than 12,500 miles a year. If you put more miles on the vehicle, you end up paying hefty penalty fees. You also can’t modify a vehicle you lease, or damage it in any way. You could be charged for every nick and scratch.
The biggest downside to leasing a car is that you have nothing of value when the lease ends. You are not left with an asset that you can sell. When you constantly lease, the payments never end.
Let’s look at five essential factors that you should be aware of when it comes to lease vs. buy:
5. Financing Options
People who buy a car outright have a number of options to finance that purchase, and they are not beholden to the dealership where they found the vehicle. These include financing through the dealership, a private bank loan, a personal loan (from a parent or friend), or by paying straight cash and not financing at all.
In contrast, people who lease a vehicle are stuck dealing with the dealership for the duration of the lease period – typically two-to-four years. They have no other options. Sometimes the relationship between a leasing customer and the dealership changes once the paperwork is signed, and not for the better — especially if any problems with the vehicle pop up. Folks who buy a vehicle outright can walk away from the dealership and never have to deal with those people again unless they want to.
4. Mileage Considerations
When someone buys a car, they are free to drive it as much or as little as they want. Whether they drive 5,000 miles a year or 30,000 miles a year, it doesn’t matter. With a lease, however, the number of miles a person can drive each year is capped. Most leases limit the number of miles a person can drive to between 12,000 and 15,000 per year (although this is sometimes negotiable beforehand).
Going over the limit means paying hefty fees to the dealership that leased them the vehicle. The annual mileage limit is in place to protect the dealership and ensure that they can lease or sell the car again once it is returned. The lower the mileage on a vehicle, the more money the dealership can charge for it at resale. However, this does nothing for the person who is leasing a car, except make them worry about how much they are driving.
3. Upfront Costs
Most car salesmen are shrewd, and they often tell customers that it is easier and cheaper for them to get into a leased car than to purchased one. But hang on a minute. When someone buys a car, they typically pay upfront costs that include a down payment, taxes, and registration fees.
In comparison, a person who leases a vehicle typically makes the first month’s payment, as well as a refundable security deposit, a down payment, taxes, registration, and other fees associated with a lease such as a “lease initiation” fee. Add these up and the upfront costs associated with a lease are often significantly higher (or at least equal) than simply buying a vehicle.
2. Additional Fees
Salespeople use dollar and cents to sell people on a lease, noting that the monthly costs of a lease are almost always lower than the monthly payments to buy a car outright. However, what they neglect to mention are the fees charged if a person has to terminate the lease before the set end date of that lease. Early termination fees can be extremely high.
In most cases, the early termination fees basically require a person to payout the remainder of the lease all at once. That means that if a person ends the lease early, the early-termination charges are as costly as sticking with the contract.
Also, the person who is leasing a car is responsible for the wear and tear. You can bet that a dealership will make their customers pay extra charges for wear and tear that is considered excessive or above normal usage. These charges are not cheap, and a lot of dealerships put their customers on the hook for any and all wear and tear on a vehicle.
To be fair, there are additional fees on a car you buy too – for things such as freight and administration. At least these fees are all upfront, and you can agree to disagree to them before you sign. When you buy a car, there are no additional fees applied years down the road.
1. Financial Asset
When a lease ends, people simply return the vehicle to the dealership. What do they get in return? That’s right, nothing. However, people who own their car outright have an asset that they can sell for money or use as a trade-in towards a new vehicle. If they’ve kept their car in tip-top shape, there’s a good chance they can continue to drive it for a few more years — without those pesky monthly payments.
Sure, a car is a depreciating asset and it’s never worth as much as you paid for it. But it’s still worth something. After driving a vehicle for seven or eight years and putting more than 150,000 miles on it, most cars can still fetch a few thousand dollars, depending on its condition.
Selling a used car that you have driven (without payments) for a couple years for $5,000 is still better than returning a leased vehicle to the dealership and getting nothing in return — as long as you don’t mind driving a car that’s almost 10 years old.
The Last Word
Car dealerships tend to favor the lease because, essentially, a lease amounts to never ending monthly payments. When one lease ends, the dealer puts you right into another lease – ensuring that the payments continue.
The most obvious benefit to buying a vehicle outright is that you will eventually pay it off and then get the satisfaction of driving it without any monthly payments. As a general rule of thumb, people should buy a car that they will be able to pay off in three-to-five years. Then, keep the car for at least eight years, and drive it payment free for as long as you can. Leases may provide lower monthly payments, but those monthly payments never stop, making them a trap for people.
With all the fees, costs and charges attached to a lease, people who choose to lease a vehicle usually end up paying the same amount of money that they would have had they simply bought the vehicle in the first place. Studies by several North American consumer groups have all come to the same conclusion – in the long run, it is no cheaper to lease a car than it is to purchase it.
So don’t always believe what the salespeople says. The repair and maintenance costs of a leased car are no cheaper, and, as we’ve pointed out, people who lease a vehicle have to worry about the mileage and wear and tear they put on a vehicle. So, in our opinion, the smart financial move is to buy a car and pay it off as quickly as you can. Your future self will thank you.