Getting a new car is a huge decision that can be very exciting – and very overwhelming. There are a million things to decide, from the make and model, to the trim level, to the color. But perhaps the biggest decision you will have to make is whether to lease or buy your new ride.
In this article, we will discuss the pros and cons of leasing and buying a new car and help you decide which is the right choice for you.
Here’s everything you need to know about leasing vs. buying a car.
What is Leasing?
When you lease a car, you are essentially renting the car for an extended period of time. Instead of paying for the whole car, you are paying for the depreciation that will occur while you are using the vehicle, plus interest and fees. Most leases are what’s called “closed-end leases”, which means that the residual value of the car is determined and contracted before you drive it home.
How are lease payments calculated?
Let’s look at how lease payments are calculated as opposed to financing payments. Here are some terms we will be using:
- Capitalized Cost- The price of the car. This can be negotiated, even if it’s a lease.
- Capitalized Cost Reductions- Any discounts or deals that the dealership may apply.
- Residual Value- The expected value of the car at the end of the lease term.
- Money Factor- This is the financing charge a person pays on a lease. This number is listed as a decimal, so multiply this number by 2400 to get an equivalent APR.
The cost of the lease is as follows:
Capitalized Cost - Capitalized Cost Reductions - Residual Value + Interest + Fees
You will have to pay lease origination fees plus registration fees, along with a down payment and security deposit. These fees are often considered “drive-off” costs which you pay upfront. The remaining depreciation and interest will be divided up into monthly payments.
For example, say you find your dream car that has a capitalized cost of $40,000. It’s residual value is $25,000, which means that you will be paying off the $15,000 depreciation. Ultimately you will be making payments on $15,000 plus interest and fees.
In general, your monthly payments will be lower when leasing as opposed to buying.
How are financing payments calculated?
Loan payments are calculated based on the entire cost of the car:
Capitalized Cost - Capitalized Cost Reductions + Interest + Fees
If you were financing the vehicle from the example above, you would be making payments on the entire $40,000, plus interest and fees. Therefore your monthly payments (and overall out of pocket costs) are less if you choose to lease rather than buy.
What are the Pros of Leasing?
Now that we’ve discussed how payments are determined, let’s discuss why leasing is a popular option when getting a new car. Here are some of the top reasons people choose leasing over buying:
You will have lower monthly payments
As we discussed above, your monthly payments will be lower when leasing as opposed to buying.
You don’t have to worry about selling
Not having to worry about resale is a huge perk of leasing. When your lease is over, you simply hand your keys back to the dealership and walk away.
You can get a new car every few years
If you love having the latest model of everything, leasing may be especially worthwhile for you. Every few years when your lease is up, you get to hand in the keys and get a new car, and whatever new technology comes along with it.
Your warranty will cover repairs and maintenance (sometimes)
New cars typically come with three year warranties, which is also the average length of a lease. This means that while you are driving your lease, most repairs (and sometimes oil changes) will be covered by the warranty.
You can maximize tax deductions
If you are a business owner, leasing a car has more tax advantages than buying a car. The IRS allows you to write off both the depreciation costs and the financing costs that are part of the monthly payments. This is more than you can write off when you purchase a car.
What are the Cons of Leasing?
You don’t build equity
The main downside of leasing is that you do not build equity. At the end of the day, you do not own your car, so it will never count as an asset for you.
There are early termination fees
If you are unhappy with your lease for any reason, there will be fees to terminate the lease. Breaking the lease early may also have negative effects on your credit score.
There are always mileage limits
When you lease a car, there are always mileage restrictions on your vehicle. Dealerships usually have annual mileage caps of 12,000-15,000 miles per year. If you go over your allotted mileage, you can pay between 15 and 40 cents per mile. This can add up to be a very hefty sum if you drive a lot.
Cost of wear and tear
When you return the car, it must be in great shape. Normal wear and tear is acceptable, but beyond that you will be charged a fee for anything they consider excessive. This can include dings, dents, and tears to the interior.
You can’t customize your car
Since it’s not really your car, you can’t customize it as you may like. You are expected to give the car back as you received it, even if you think the upgraded wheels or spoiler add to it’s value.
There are often restrictions on use
Many leases have use restrictions built into their contracts. In addition to the mileage limits, you may be restricted against driving the car out of the country, or they may say that you are unable to use the car for rideshares (like Uber or Lyft). They might even state that you are unable to use the car for business. If you want to use your car for anything other than commuting and routine driving, leasing might not be a great option.
So Should I Buy Instead? What are the Pros of Buying?
You own the car
At the end of financing, the car belongs to you completely. It is an asset that helps build your equity.
There are no limitations
Since you own the car, you do not have to worry about mileage limits or wear and tear. No one can tell you where to drive the car, or how to use the car. And you can customize it however you would like. Even if you are financing the car and don’t own it outright just yet, loans typically do not have the restrictions that leases have.
Financing is often easier than leasing
In general, it is easier to get a loan than it is to get a lease. The credit requirements are usually lower and people are more familiar with the process of getting a loan rather than getting a lease.
You can sell it whenever you want to
Unlike a lease, you can sell your car whenever you want to sell it. While it is almost always a good idea to wait until the loan is paid off, once it is paid off you have an asset that you can sell whenever you want.
You decide when – and how – to fix things
When something goes wrong on a leased car, you will need to either go to the dealership or to a certified mechanic to get it fixed. But when you own the car, you can handle it however you’d like, and whenever you’d like. If you want to use factory parts to fix it, you certainly can. But you can also opt for cheaper parts and cheaper labor if you choose.
What are the cons of buying?
You pay interest on the entire cost of the car
When you lease, you are only paying interest on the capitalized amount minus the residual amount (the depreciated amount) as opposed to paying interest on the entire cost of the car.
You may need to make a down payment
To get the best rates, you will usually have to pay a down payment. Doing so will lower your loan to value ratio (LTV) and get you a better APR. This means that your upfront cost as well as your total cost will be much more than when you lease.
The warranty will end
When you buy a new car, you will have a warranty for the first few years. But after that, you are on your own for any repairs and maintenance.
Those are the major differences between leasing and buying a car.
There are pros and cons when it comes to leasing and buying cars, and you will need to decide what works best for your situation. If you use your car sparingly and prefer to have a nice, new car every few years, leasing is perfect for you. But if you drive a lot and love to customize your car, leasing is probably not a great option for you.
Already in the middle of a financing arrangement? We may be able to get you a better rate! Contact Auto Approve to see how we can save you money today.