One of the most common questions I am asked as a financial planner is “should I lease or buy my car?” Leasing commercials on the radio make it sound like leasing a car is the only cheap, intelligent choice. However, it really depends on how you define “cheap.” If it means a lower monthly payment, then leasing is usually cheaper. If it means what you pay long term, though, leasing is usually not the best option.
What’s the Process of Buying a Car?
Buying a car is a relatively straightforward process. Essentially, you negotiate the price of the car at the dealership and you secure financing. After providing a down payment, you’d finance the entire remaining value of the car, usually through a loan from a bank or credit union. You would then make payments that include both principal and interest for a specified period of time. Once your contract is complete, and the loan or other financing is paid off, you’d own the car outright.
At that point, you could decide to keep it or sell it. If you sold it, you’d have to negotiate the sale to get the price you want. One disadvantage of owning the car is that thanks to regular wear and tear and other factors, you have no guarantee of what the car will be worth at the end of the financing period.
How is Leasing Different from Buying?
Leasing is a bit more complicated, but it’s basically just another method of financing a car. The difference is you aren’t financing the entire car—just the use of the car during the first few years of the car’s life. The payments you make would still consist of principal and interest, but only for the portion of the car’s life you’d be using up.
The biggest difference is that unlike buying a car, you don’t own anything once a lease is complete—and if you still needed a vehicle, you’d have to acquire another one. Typically, you can purchase the car for a pre-set price (known as the residual value) once the lease term is over, or you can give the car back to the leasing company and decide to either purchase or lease another vehicle.
Do You Have to Pay Extra Fees to Lease a Car?
Many advertised leases also require a down payment. If you’re short on cash, you can skip the down payment, but your monthly payment would be higher because you’d be financing more of the car. Also, keep in mind that you’re still responsible for the condition and mileage of the cars you lease. When you turn the car back in, if it isn’t in good condition or if you’ve driven more miles than your lease allows (around 12,000 miles per year), then you’ll have to pay extra.
When Is It Better to Lease Rather Than Buy?
Before you decide to lease or buy, you’ll also need to determine how many miles you drive per year and how long you like to keep your cars. If you are a high mileage driver (say, more than 15,000 miles per year) or you like to keep your cars for three years or more, you are most likely better off purchasing the car. If you don’t drive much and you prefer driving new cars, then leasing may be a better option for you.
Regardless of whether you lease or buy, you’ll need good credit to qualify for a low interest rate. So before you shop for a car, see where you stand: check your credit score for free at Credit.com.
Americans love a good rivalry: Yankees versus Red Sox, Coke versus Pepsi, and most of all, leasing versus buying.
Leasing a car is sizzling hot right now. New data show one out of every three new cars is leased. And leasing may very well rule the future, as it shot up 46% over the last five years among millennial new car buyers. To those who think leasing is always a terrible deal, this is a travesty. To leasing fans, it’s vindication.
The topic of car leasing brings out a lot of emotion in drivers. Many people think leasing is non-sensical because after making payments for three years, consumers own nothing. But, in reality, that’s an inaccurate assessment and whether or not you should lease depends — not only on the driver’s needs but on those of the auto industry. Sometimes car makers offer incentives that make leasing attractive. So those who dismiss leasing outright could be missing out.
The truth is, leasing is more expensive than buying most of the time. The average American keeps a new car for six-and-a-half years, but a 2012 survey found Americans intend to keep their cars for up to 10 years. In either case, buying will probably be cheaper than leasing because when you buy a car, the monthly payments will eventually stop. Pay off a car loan, you keep the car; pay off the lease, you just get another. So the longer you intend to keep a car, in general, the better it seems to buy.
Yet even this equation comes with a hitch. My four-year-old Toyota Rav4 needed a new transmission recently. But as a high-mileage driver, I was out of warranty, and worst of all, out of luck. My repair bill was $5,000 (although Toyota kicked in $1,000 when I complained).
The advantage renters have is like the advantage renters have over mortgage holders — no surprise repair bills. As long as drivers stay within mileage limits, whatever happens to the car will generally be covered under warranty. As one reader on my website put it, “I’ve been leasing for about 10 years now. No unpredictable repair shocks to my wallet because I’m always driving a new car.”
Of course, mileage caps are another factor in the lease vs. buy dilemma. Those with long commutes or who like to travel generally shouldn’t lease because leases tend to limit drivers to about 1,000 miles per month. Exceeding the limit is expensive and can cost from 10 to 30 cents per mile. Also, watching your miles every week is a drag. Imagine turning down a road trip because of your mileage cap. This is especially critical, as dealers have been sweetening lease deals lately with even more complex, i.e., lower, mileage caps.
One factor often cited as a reason to buy is equity. It’s usually stated like this: “With buying, you own something of value after you pay off the loan. With leasing, you have nothing at the end.” But that’s just part of the story. Cars are terrible assets; they lose value quickly and in unpredictable ways. In the end, I find most five- or six-year-old cars are worth a few thousand dollars as trade-ins.
Online auto valuation sites may say your car is worth more, but what matters is what you walk away with. Used car sales are so clunky, it’s silly to use those lease vs. buy calculators and feel vindicated you saved $982 on a vehicle you owned for five years. You may have given that value back to the dealer when you received wholesale value instead of street value.
In the end, people want — and need — reliable transportation, so you can see why leasing’s attractive.
When Leasing Can Beat Buying
Less sales tax: You don’t pay sales tax on the full price of the car but on the value of the car used during the lease. (If you buy the car at the end of the lease for its established ‘residual value,’ you’ll pay the rest of the sales tax.)
Tax perks: For some folks, leasing is a much easier tax write-off.
Luxury: You’ll probably be driving around in a nice new car every three years.
It feels cheaper: Monthly and down payments will probably be lower.
No repair surprises: Fear of big repair costs will definitely be lower.
Buy ‘used’ for less: Particularly low-mile drivers may get a bargain at the end of the lease by buying the car at residual value. (Sometimes, but rarely, is this cheaper than buying the car in the first place.)
When Buying Can Beat Leasing
End-of-lease risks: What happens when the lease ends? “Wear and tear” damages can turn a good deal bad quickly. And the dealer pretty much has the upper hand. You generally have no bargaining power, unless you’re about to buy or lease another car.
Inflexibility: Young people seem attracted to leases because they feel flexible. But leasing is often less so because it’s much harder to get out of a lease than sell a car (even a car with a loan balance). What happens if you take a job where you can’t have a car? Leaseholders can get really burned.
Miles: A thousand miles per month may sound like a lot to you today, but what if your company moves 35 miles away months from now? Mileage limits can be pretty oppressive, especially in a world of unknowns. The average 20-something holds 7.2 jobs before age 29.
Overall cost: Leasing is more expensive than buying, even with a loan. But here’s a simple way to look at it: Both are methods of financing a car. With leasing, since you’re paying less upfront, you’re borrowing more longer. So, of course, it costs more. Another way to look at it: With leasing, rather than making a down payment upfront, you can make a down payment three years into having the car (buying for its ‘residual value’). That essentially means you’re borrowing more longer.
As with all generalizations, these concepts may be more or less true based on your unique car deal. Remember, everything is negotiable at a dealership: upfront costs; monthly payment; residual value; ‘money factor’ (leasing speak for interest rate). Even mileage is negotiable since you can buy extra miles upfront for less than you’d pay after three years. It’s possible to lower leasing risks through negotiation or car-maker incentives. If so, leasing may be right for you. (A good credit score can give you more bargaining power on auto financing. You can see where your credit currently stands by viewing your two free credit scores, updated each month, on Credit.com.)
The Bottom Line
Leasing is a bit too much like the Eagles’ song “Hotel California” for my taste. Once you check in, it’s pretty hard to check out. Renters turn in cars and get new leases, and they tend to do so at the same dealerships, for the reasons mentioned above. You’ll never escape the monthly car payment. And worse, perhaps you’ll get a good lease deal today, but three years from now, leases could fall out of favor and you’d be stuck.
In the end, leasing is a seductive but generally a bad plan for saving money. But for folks who care less about money and more about having a new car every three years, don’t drive often and lose sleep over repair bill risks, it can make sense.