Leasing vs. Buying a Car: Everything You Need To Know

The buy vs. lease debate is one of my favorites because people usually feel pretty strongly about which one they think is better. For some people, leasing makes no financial sense and for others it makes all the sense in the world. Others think buying is the way to go, and some feel that buying a car should be avoided. Then, there is the group in between who really don’t know the difference. So, we’ll go over the differences so that you can decide on which side of the fence you sit.

Buying vs. Leasing – the difference

Buying

You can buy a new or used car in one of two ways. The first, you pay cash for it so you own it out right – no car payments, ever. The second, you can take out a loan to finance your car purchase and make payments on the loan until the car is paid off. You can finance the entire purchase price of the car or you can pay a down payment and finance the remaining amount. The more you put down, the less you’ll have to borrow, and the less you’ll pay over the course of the loan. Once your loan is paid off, you own the car completely and car payments are no longer an obligation in your life.

When it comes to taking out an auto loan, you can do this directly at the dealership or go to your bank or credit union to get pre-approved first. (Side note: Rates are lower at a credit union!) When you get pre-approved, you’ll know the maximum amount you are qualified for, as well as your loan information, including your term and interest rate, which is what the lender uses to determine your monthly payment. This will help you narrow down your car choices to what you can actually afford. You can input this data into a financial calculator – like this – to tell you what your monthly payment would be each time you find a car you may be interested in purchasing.

Once you find the car you want, you can submit the official loan application and be on your way with your new wheels.

Leasing

When you lease a car, you basically rent a car for a certain amount of time, usually for a 24- or 36-month-term. So, you don’t own the car. While leasing is available on used cars, most advertisements and dealership offers are for leasing a brand new car. And I am talking brand spankin’ new with no previous owners and not many miles on the odometer.

You’ve heard the saying – your car loses its value as soon as it drives off the lot. Because you only drive your leased vehicle for a short time period, you pay for the loss of value during that timeframe, not what the car is actually worth when you pick it out. Your monthly lease payment is made up of the following:

  • Capitalized Cost (“Cap Cost”): The price of the car negotiated down from the MSRP (Manufacturer’s Suggested Retail Price)
  • Residual Value: The estimated value of the car when your lease is over
  • Depreciation: The difference between the Cap Cost and Residual Value (i.e. If your car’s Cap Cost is $25,000 and at the end of the lease your car is worth $18,000, your car’s Depreciation is $7,000)
  • Money Factor: The interest you pay on the lease. When you lease a car, the leasing company purchases the car from the dealership, and you pay interest to the leasing company.
  • Taxes: This depends on your state’s sales tax rate.

Depending on the terms of your lease and what you are able to negotiate, there may also be money “due at signing” as you’ve heard on many commercials for lease offers. This could include a down payment, your first month’s payment and a host of fees including Acquisition, Documentation, Tag, Title, and Registration fees. There is also the option of rolling these fees into your monthly payment.

Once your lease is up, your options are to buy that car or a different car, lease another car or walk away with nothing to drive.

It’s important to note that whether you decide to lease or buy, your credit score will influence the terms you receive for your loan or your lease. The lender or dealer will use your score to determine your rate. The better your score, the better your rate.

Now let’s talk pros vs. cons.

Pros of Leasing

  • You get a brand new car every 2-3 years with some or all of the latest tech and safety features.
  • You pay less in repairs because your car is covered under the manufacturer’s warranty.
  • You worry less about repairs or potential problems than you would with a used car.
  • Your monthly payment is typically lower.
  • You could potentially have a lower down payment, or no down payment at all.
  • You have the option to buy your leased vehicle at the end. This makes it so you’d buy a used car with you as the only user.
  • The process is easy and streamlined – pick your car, sign the paperwork and drive .
  • You don’t have to worry about past ownership, accident or repair history.
  • You don’t risk owing more on a car than what it’s worth because you’re not borrowing money to pay for the car and you technically don’t owe anything. This is known as “being upside-down”.

Cons of leasing

  • You don’t own the car.
  • You are limited to the amount of miles you can drive per year, usually 12,000 – 15,000. If you go over, you’ll have to pay a fee per each mile you’re over by.
  • Taxes are more expensive on newer cars.
  • You can’t customize or make any upgrades to your vehicle (i.e. change the color or rims, or install an automatic starter). If you do, you have to remove those upgrades or customizations before returning your car.
  • You can’t look forward to a time when no car payments exist.
  • You may get charged with excessive wear-and-tear fees upon turn-in.
  • You may have to pay a penalty if you want to terminate the lease agreement.

Pros of buying

  • The car is YOURS.
  • You can make any upgrades or changes you desire.
  • There is no limit to the amount of miles you can drive.
  • You build equity in the car you own so that you can sell it for value or trade it in for a different car (as long as you don’t owe more than it’s worth, a.k.a. “negative equity”).
  • You may pay less in the long-term.
  • Eventually you will pay off your loan and can say goodbye to car payments.

Cons of buying

  • You may not get to drive the latest and greatest car (this doesn’t matter to some).
  • Your monthly payment will most likely be higher.
  • You risk being “upside-down” on your car. Avoiding this usually requires a higher down payment. In the event of an accident where your car is totaled, or if your car is stolen, GAP insurance would help cover the difference between what you owe on the car and it’s actual cash value (Say you owe $10,000 on your loan, but your car is worth $7,000, GAP insurance would cover the $3,000 difference, excluding your deductible.)
  • You may have to deal with hefty repair costs.
  • Since cars consistently lose their value over time, you own a depreciating asset.
  • The trade-in process can be a hassle.

Some of the great things about leasing are the pure convenience of driving a new car and not worrying about repair hassles and costs, as long as you don’t get into an accident, of course. Also, the lower monthly payments are always nice. On the other hand, people like to buy rather than lease because of the freedom and sense of ownership that comes along with the purchase. Plus, a future with no car payments is alluring.

Whether you lease or buy depends completely on your individual lifestyle, financial situation and desires. If you’d rather drive a new car every two to three years, pay less per month and not worry about ugly repairs, leasing is the way to go. If you don’t mind driving the same car for many years, you’d rather own your car (even if it means working toward paying it off), can afford repairs, and you don’t want to deal with the terms that come with a lease, then buying is probably better for you. There are advantages and disadvantages to each choice. Your decision is based on what you’d rather deal with and how you’d like to spend your money.

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