Choosing whether to lease a new vehicle instead of buying it largely comes down to priorities. For some drivers, leasing or buying is purely a matter of dollars and cents. For others, it’s more about forming an emotional connection to the car. Before choosing which road to go down, it’s important to understand the key distinctions.
The Basics of Leasing
When you lease a vehicle, you're basically renting it from the dealer for a certain length of time. That's usually 36 or 48 months. Once your lease period ends, you have the option of returning the vehicle to the dealer or purchasing it at a pre-determined amount, which is defined in the lease contract.
That's a lot different from buying a car. Buying it outright means you own it after the loan is paid off.
- The monthly payments for a lease are usually lower than for a loan.
- You're not building up any equity in the vehicle with those payments.
- You can buy the vehicle at the end of the lease for a pre-arranged price.
Lease payments are generally lower than the monthly loan payments for a new vehicle.
Monthly car loan payments are calculated based on the sale price, the interest rate, and the number of months it will take to repay the loan.
Lease payments depend on factors including:
- Sale Price: This is negotiated with the dealer, as with a vehicle purchase.
- Length of the lease: This is the number of months you agree to lease the car.
- Expected mileage: The lease sets a certain maximum number of miles you can drive the car each year. Most leases come with a 10,000-mile annual allotment. The monthly payment will increase slightly if you go for a higher yearly mileage. If you exceed the mileage limit in the contract, you'll owe the dealer cash for every extra mile at the end of the lease.
- Residual Value: This is the value of the vehicle at the end of the lease, with its depreciation figured in. If you decide to purchase the vehicle once the lease expires, this is the amount you will pay.
- Rent Charge. This fee is shown as a dollar figure rather than a percentage, but it is the equivalent of an interest charge.
- Taxes and Fees: These are added into the lease and affect the monthly cost.
Some dealers or the manufacturers they represent require a down payment for a lease. The more you put down, the lower your lease payment will be.
Keep in mind, it may not make sense to put too much cash down on a vehicle that you'll ultimately be handing back to the dealer. If you're quite sure you're going to buy it when the lease expires, it will reduce the cost then.
Advantages and Disadvantages of Leasing
The major drawback of leasing is that you don’t acquire any equity in the vehicle. It’s a bit like renting an apartment. You make monthly payments but have no ownership claim to the property once the lease expires.
In this case, it means you can't sell the car or trade it in to reduce the cost of your next vehicle.
However, there are advantages to leasing as well. They include:
Lower Monthly Payments
If you're concerned about the monthly costs, a lease eases the burden a bit. Generally, the monthly payment is considerably less than it would be for a car loan. Some people even opt for a more luxurious car than they otherwise could afford.
Make sure your insurance covers any charges that may still be due even if the car is totaled before the lease runs out.
A New Car Every Few Years
For many people, there’s nothing like the feeling of driving away in a brand new ride. If you’re one of them, leasing may be the way to go. When the lease is up in a few years, you can return it and get your next new car.
Many new cars offer a warranty that lasts at least three years. So when you take out a three-year lease, most of the repairs should be covered. Leasing arrangements largely eliminate the hazards of a significant unforeseen expense.
No Resale Worries
Are you the type of person who hates to haggle? If so, you probably hate the idea of selling your used car to a dealership or a private buyer. With a lease, you simply return the car. The only thing you have to worry about is paying any end-of-lease fees, including those for abnormal wear or additional mileage on the vehicle.
Maximizing Tax Deductions
If you use your car for business purposes, a lease will often afford you more tax write-offs than a loan. That’s because the IRS allows you to deduct both the depreciation and the financing costs that are part of each monthly payment. If you’re leasing a luxury automobile, the amount you can write off may be limited.
If you’re thinking about the long-term financial impact, leases look less attractive. Because you don’t build equity and have to pay certain fees that don’t come with a loan, including an acquisition fee (also called a lease initiation fee), experts say it’s usually cheaper overall to buy a car and hold onto it for as long as possible.
Leases also provide less flexibility than buying. The contract discourages any customization. In fact, the finance company may require that you reverse any modifications prior to returning it, which can be both a pain and an extra expense.
Also, if the car is totaled in an accident before the end of your lease, you may be liable for some costs not covered by your car insurance unless the lease includes car gap insurance. This type of insurance covers any costs that might be required before the lease expires, even if the car is scrap.
If you decide that taking out a loan is preferable to leasing a vehicle, then it's worth using an auto loan calculator to determine what loan term and interest rate would best suit your needs.