If you are in the market for a new car, chances are you have at least contemplated the decision between buying or leasing. Choosing which route to finance your new vehicle largely comes down to your priorities. For some drivers, getting a new car is only a financial decision. For others, it is about forming an emotional connection to the car. Before deciding if buying or leasing is right for you, it is important to understand the key differences.
Buying a Car
When you buy a car, you pay for the entire value of a vehicle, regardless of how many miles you drive it or how long you keep it. You can pay cash or get an auto finance loan. You have the option to sell or trade the vehicle at any time. When the car is paid off, you can continue to drive it while enjoying no further monthly payments.
- If you decide to purchase a new car, I would be cautious deciding the length of the loan term. On one hand, if you choose a short loan term, your car payments may be too high. However, the longer you extend out the term, the more interest you will owe over the course of the loan.
- According to IHS Automotive, the typical American consumer holds on to a new car for 6.5 years. Therefore, if possible, I would recommend using a loan term shorter than that. In my opinion, if you are considering a loan term that is longer than 5 years, you should consider a cheaper vehicle.
Leasing a Car
A car lease is a method of obtaining a new car that involves only paying for a portion of the car’s actual cost as opposed to having to pay for the car in its entirety. That “portion” you use is the amount of depreciation the vehicle will suffer over the course of your lease. Typically lease terms are between two to four years. Additionally, you are usually allotted only 10,000-15,000 miles per year.
For example, pretend you want to do a three-year lease on a new car that costs $25,000. Assume that the finance company believes that this car will depreciate to $12,000 by the end of the term. The $13,000 worth of depreciation in value is what a majority of your monthly lease payments go toward. Note, lease payments also imbed applicable taxes and the cost of financing.
At the end of the lease term, you have two options. One option is to return the leased car and finance a different vehicle. The other option is to purchase your leased car for the residual value. The residual value is an expert guess as to what your car will be worth when the lease ends. In the previous example, the residual was $12,000.
- If the residual value of your car is more than the market value at the end of your lease term, it is best to return the vehicle to the finance company from a pure financial standpoint.
- If the residual value of your car is less than the market value, you have a couple of options. First, you could purchase the vehicle at the residual value and resell it at the market value to make a profit. Alternatively, a car dealer could buy the car from the leasing company at the residual price then apply some of that “equity” in the car toward a new car purchase or lease.
- In my opinion, I would not lease a vehicle longer than its bumper-to-bumper warranty term. Most manufacturers offer a bumper-to-bumper warranty that covers a new vehicle between 3-5 years or 36,000-60,000 miles whichever comes first. Make sure to do your research as every company is a bit different.
What to Consider When Buying vs. Leasing
Leasing a car usually will have a lower monthly payment compared to buying a car with the same loan terms. This is because with a lease you are only paying for the depreciation of the car during those years rather than the whole vehicle cost. Therefore, if you need access to more cash every month, leasing may be more favorable.
Length of Ownership
If you intend to keep your car for less than four years, leasing will most likely make more sense. As mentioned before, lease payments are usually the cheapest option. If you were to purchase a car and sell it every few years, you would have to deal with the hassle of selling that car. At the end of a lease term, assuming you return the car in good condition, the finance company has to take it back. Another thing to consider is that leased cars are most likely covered under the manufacturer warranty. Thus, if your car has a manufacturer defect, you will be covered during the term of your lease.
If you intend to keep your car for a longer period of time, purchasing a car will likely be most economical. Assuming maintenance costs are minimal, the cost of ownership will be considerably less than leasing once you paid off the car.
Leasing a car usually comes with a 10,000-15,000 mile annual allotment. If you drove over this amount, depending on your lease agreement, you will owe excess mileage charges. This is usually around $0.15-$0.25 per additional mile. Therefore, if you drive many miles a year, leasing may not be practical. If you are a low mileage driver, leasing is a viable option.
If you buy a car, you will not be penalized for driving it excessively. However, if you decide to sell the car at a later date, it will be worth less. Obviously, the more you drive your car the more likely parts will start to break down.
Care & Maintenance
If you are prone to getting scratches on your car or have a high risk of damaging it, leasing may not be for you. This is because you may be charged “wear-and-tear” fees at the end of your lease term. The definition of “wear-and-tear” varies between car companies. If you decide to lease a car, get clarification from the dealer.
Using the criteria above, the following are simplified scenarios to illustrate when buying or leasing a car may make more sense. If your financial situation is more complex, your car purchasing decision may be less clear.
The Heavy Mileage User
Tim is a farmer who wants to replace his aging Ford F150. He wants a new truck to haul stuff around his property. In addition, he wants to tow his camper trailer every year on a cross country trip for his family. Early in his career, he was a mechanic at a local repair shop.
Based on Tim’s driving profile, he may be pretty rough on his vehicles. In addition, given he goes on a cross country trip, he must drive many miles a year. Since he has skills as a mechanic, he is probably comfortable repairing his own car. Given the circumstances, buying a car makes the most sense.
The Car Performance Enthusiast
Chris is a young car enthusiast who likes to customize his cars. He wants to purchase a Dodge Charger Hellcat and add a few modifications that will increase performance and exhaust sound. On the weekends, he likes to go with his friends to the local track and drag race.
Since Chris likes to customize his cars, leasing will not make sense as he is expected to return the car with all stock parts. Also, racing may increase his risk of damaging his vehicle. Therefore, buying a car makes more sense than leasing.
The Luxury Car Perfectionist
Mario is an accountant with extra disposable income and assets. He likes to drive a different new luxury car every few years. He drives very few miles due to his predictable lifestyle. In addition, he takes great care of his car by following the recommended maintenance schedule and going to the car wash every week.
Mario’s profile is the perfect example of when leasing can make sense. Since he drives few miles and takes great care of his car, he does not have to worry about incurring extra fees when he turns his car in at the end of his lease. In addition, he is able to get into a different car without worrying about selling his old car. Leasing allows Mario to get the most car without much upfront financial commitment.
If Mario leases cars in the long-term, it will be more expensive than buying a car and keeping it for a long time. However, he is indifferent because he wants the luxury and convenience of leasing.
The Cash Flow Optimizer
Rochelle is a substitute teacher and a part time waitress on the weekends. She does not have enough money to afford a down payment to purchase a new vehicle. In addition, she does not want to buy a used car because her previous car had many maintenance issues. She is contemplating leasing a base Toyota Corolla to help her get around town.
In an ideal world, people who have limited income or assets would purchase a cheaper used car. However, this is not always practical given this example. In this case, Rochelle may be a candidate for leasing as she would be able to drive a new car that is covered under warranty. In addition, many leases have the option of no down payment and feature a lower monthly payment than purchasing a vehicle.
Over the long-run, Rochelle will be paying more for leasing vehicles than buying a car and keeping it for a long time. However, she is indifferent because her cash flow does not give her any alternatives other than buying a used car.
As with any major financial decision, it is important to do your homework before deciding to buy or lease a new car.
The best decision for you depends on your preferences, budget, and how mindful you want to be of any expenses you might incur in the future.
If you are working with a financial professional, I recommend talking with them about your car purchasing decision so you can get an individualized evaluation. Since purchasing a car can be an emotional experience, it may be helpful to get a third party opinion.