Learn the differences between buying and leasing a car to help decide which is best for you and your lifestyle.
There’s more than one way to get behind the wheel of a new car. You can go the traditional route of buying your next vehicle and financing much of the purchase price, or you can lease a new car and only pay a fraction of its sticker price.
Car leasing was once an option reserved for businesses and customers wanting luxury cars. Today it’s common in all classes of the market, from subcompact cars to pickups and luxury SUVs. About three in ten new cars that leave dealer lots are leased.
- How Does Leasing a Car Work?
- How Does Buying a Car Work?
- What are the Benefits of Leasing a Car?
- What are the Downsides of Leasing a Car?
- What are the Benefits of Buying a Car?
- What are the Drawbacks of Buying a Car?
- How Do You Buy a Car?
- How Do You Lease a Car?
Finally, we’ll look at leasing used vehicles, and touch on a new way to get a car – the subscription model.
What Is Leasing?
Leasing is a form of car financing where you don’t pay for the entire car. When you lease a new car, you just pay for the depreciation that occurs over the term of the lease, plus fees and interest. There’s often an amount due at signing, then the balance of the cost is paid over the duration of the contract in a series of monthly lease payments. Though the concept is simple, leasing a car is a complex transaction with its own vocabulary and a potentially confusing array of numbers.
A few terms that you’ll want to be familiar with are:
Capitalized cost: The capitalized cost (or cap cost) is essentially the price of the vehicle. You should negotiate this price just as if you were buying the car. Any discounts off the capitalized costs, such as special lease deals from automakers, are called “cap cost reductions.”
Residual Value: A vehicle’s residual value is its expected value at the end of the lease period. It is rarely negotiable.
Money Factor: In the language of leasing, the money factor represents the rate of interest that you will pay. To convert the money factor to a more familiar annual percentage rate, multiply it by 2,400. You can do the math yourself, or rely on an online money factor converter to do the interest rate conversion for you.
The amount you pay for leasing a vehicle is the capitalized cost minus the residual value, plus interest (based on the money factor) and several fees, including lease origination and vehicle registration costs.
For example, if you lease a pickup truck with a capitalized cost of $40,000 and a residual value of $25,000 after three years, you’re responsible for paying $15,000 plus interest and fees.
Dealerships will often refer to the amount of your down payment on a new lease plus any other costs you have to pay up front as drive-off costs.
The most common lease periods are two and three years, though you can negotiate contracts with different terms. Most automaker-subsidized lease deals are for two- and three-year leases.
What Is Buying and Financing?
When you purchase a car, you pay the entire negotiated price of the vehicle using cash, financing, the value of your trade-in, or a combination of all three. If you buy a $30,000 SUV, for example, you have to pay $30,000. Spending that amount usually involves a down payment, your trade-in, and an auto loan.
When you purchase and finance a car, the lender holds the title until you pay off the financing, then you will own the vehicle free and clear. Purchasing cars, rather than leasing them, is still the most popular way that Americans acquire vehicles.
Financing a vehicle involves getting a car loan from a lender such as a bank, credit union, or finance company. You pay down the amount of the loan (its principal) and the interest in a series of equal monthly loan payments. The length of an auto loan is called its term, and loan terms commonly vary from a few years to seven or eight years.
What Are the Benefits of Leasing a Car?
Leasing a new car has several distinct advantages over buying a new vehicle. We’ll look at several of them in depth.
Lower Monthly Payments
Because you are paying for the depreciation that occurs during the term of your lease, monthly payments are almost always lower with a lease than they are when you are buying a car. While it’s never a good idea to base your decision on monthly lease payments alone, finding a payment that fits into your monthly budget is important.
By leasing, you may be able to get a nicer car or afford a few extra options for the same monthly payments as you would have if you were buying.
Latest Tech
In order to get the latest safety and connectivity tech, you really need to have the newest car you can find.
The latest models are loaded with advanced safety features and advanced driver assistance technology, such as automatic emergency braking, adaptive cruise control, lane keep assist, and semi-autonomous driving systems. Advanced connectivity features, such as 4G LTE data connections and support for Android Auto and Apple CarPlay are now common even in lower-priced vehicles.
Depending on the vehicle you lease, you can find a model with better fuel economy than similar models from just a few years ago.
Warranty Coverage and Maintenance
Unless you are putting a lot of miles on your new ride, it will be covered by the manufacturer’s warranty for the entire time that you’re driving it, since the term of most leases is just a few years. You don’t have to worry about the cost of expensive repairs, as your dealership’s service department should take care of any problems that occur.
Some leases include periodic maintenance for all or part of the lease term. That gives you a low and predictable total cost of ownership, with few unexpected out-of-pocket expenses.
Ease of Trade-In
When your lease is up, you can simply drive the car to the dealership and walk away after paying any final fees, along with any charges for excess mileage or excess wear. Of course, many leasing customers won’t actually walk away – they’ll drive off with a newly leased car. With leasing, you don’t have to worry about the hassle of selling or trading in your old car, or haggling over its trade-in value.
Sales Tax
Depending on where you live, leasing a car can save you a tremendous amount of money in sales tax. In some jurisdictions, you only have to pay tax on the amount you put down and on your monthly payments.
In other areas, you have to pay sales tax on the entire value of the car, which makes leasing a less attractive proposition. When you buy a car, you’re generally liable for sales tax on the whole purchase price, less the value of your trade-in in most states.
You’ll want to check with a tax professional who understands your particular circumstances and the specific tax laws of your location.
Smaller Down Payment
When you lease, you’ll often have a smaller down payment than if you buy. In fact, some leases require nothing due at signing. Many experts advise that you negotiate the lowest amount due at signing as you possibly can. If you pay a huge amount up front and wreck the car on the way home from the dealership, all of your down payment money is gone. Make a small down payment, and you’ll have less exposure to losing that money.
What Are the Downsides of Leasing a Car?
Of course, leasing a new car isn’t the best solution for everyone. There are several disadvantages you should be aware of before you leap into a lease.
No Ownership
When you lease a vehicle, you are not its owner. It’s like paying rent for an apartment, rather than a mortgage for a home.
The vehicle is owned by the leasing company that allows you to drive it as long as you fulfill your contract obligations. If the vehicle is totaled or stolen, the leasing company would be paid off for the value of the car, and you’d need to go lease or finance and new car.
Limited mileage
Leases come with strict mileage limits, and they can get costly if you exceed those limits. Depending on the car, typical excess mileage charges range from 15 to more than 30 cents per mile. If the excess mileage charge is 25 cents per mile, for example, a 20-mile round trip commute will cost you an extra $5 per day.
Though lessors tell you the number of miles you can drive per year, they don’t check each year to ensure that you are under the limit. The total allowed mileage is the number of years multiplied by the number of annual miles allowed. That’s the total you can’t exceed over the term of the loan.
The expected number of miles is priced into the lease. If you are way under the mileage cap when you turn the vehicle in, you’re essentially paying a bunch of extra money for miles you didn’t drive. You can avoid this pitfall by accurately estimating the number of miles you drive each year. If you have no idea how many miles you drive each year, you’re probably not the best candidate for a lease.
You Can’t Customize Your Ride
If you are the type of consumer who likes to make your ride unique by adding fancy wheels, off-road gear, or other customized features, you’ll need to remove all of those items before you return the vehicle at the end of the lease. While you might think the alterations enhance the vehicle’s value, your lease papers likely say that the car must be returned just as it left the showroom, less normal wear and tear.
No Cash For Your Next Car
Although there are a few ways to get a bit of cash at the end of your lease, most leaseholders will walk away from the end of their contract without getting any cash back. In fact, if you have excess mileage or wear, you may have to pay some money when you turn the car in.
That means you won’t have a trade-in or any cash to use as a down payment on your new lease. It’s not a problem if you can find a zero-down lease every few years, but if your next lease or purchase requires cash, you’ll have to dip into your bank account to find it.
Lease-End Costs Can Surprise You
We’ve touched on it already, but it’s worth repeating: You may not be able to walk away at the end of the lease without paying some money. If you are over your mileage limit, you’ll certainty have to pay. Figuring the costs of excess wear are a bit more elusive, however, as the dealership has some discretion about what to charge you for and how much you’ll have to pay.
Often they use the “credit card test” to determine what body damage is acceptable. If the ding can be covered by a card the size of a credit card, they won’t charge you. If it is bigger than a credit card, they will. In general, any damage to the glass (including nicks) will cost you at the end of the lease.
Your standards for what constitutes a soiled or worn interior may differ from those of your dealer. What you consider to be perfectly fine may be seen as an opportunity for the dealer to charge you.
Restriction on Use
Many lease agreements have strict limitations on where you drive your car and what you can drive it for. For example, you may not be able to take the car out of the country without written permission from your leasing company (though the same restriction sometimes applies to financed vehicles).
If you intend to use a leased car for a ride-hailing company such as Uber or Lyft, there are several things you need to think about. You’ll want to carefully examine your lease agreement to ensure that it doesn’t preclude business use outright. Driving for Uber or Lyft will likely put a ton of miles on your car, so you’ll need to make sure you don’t have mileage restrictions that will make such use very expensive. Finally, your car will probably suffer accelerated wear and tear, and that can cost you quite a lot of money at the end of the lease.
Bottom line: If you’re planning to use a leased vehicle for anything other than routine driving, be sure to check with your leasing company to ensure that such use is allowed.
You Need to Have Excellent Credit
While it is possible to lease a car with bad credit, it can be much more complex and expensive than if you have excellent credit. In general, leasing companies cater to customers with good credit. Most automakers set the bar even higher, by only offering their best lease deals to lessees with top-notch credit scores.
Well before you even think about leasing a vehicle, you should check your credit score and the credit reports used to generate that score. You’ll then have time to correct any errors on the reports and work to improve any problem areas. Credit reports take time to correct, and credit scores take time to move. You’ll have to show some patience with the process if you want to qualify for the best deals.
You Have to Buy Gap Insurance
Nearly all leasing companies will require you to purchase gap insurance, which covers your leased vehicle if it is stolen or totaled. Even if the lessor doesn’t require the coverage, it’s critical that you have it so you’re not out thousands of dollars if something terrible happens.
Many dealerships won’t tell you that you don’t have to buy the coverage from them. Most auto insurance companies sell it, and many financial institutions offer the coverage – even if you don’t have financing from them. Before you head to the dealer, you should research the cost of the coverage, and have a written offer in hand from an outside source that the dealer has to beat to get your business.
Some lease contracts have gap coverage built in. You’ll want to read the paperwork closely to see what the actual cost of the coverage is.
It Is Complicated
Leasing a new car is a complicated transaction. It’s easy to be confused by the different language and terms used in lease negotiation. Unfortunately, confusion can lead to you getting a lousy deal. If there’s something you don’t understand, you’ll want to slow down and figure it out before you sign the paperwork.
You might even consider having your attorney or accountant look over the contract before you agree to it. If the dealership or finance company balks at the delay, you should consider it a red flag and walk away from the deal.
What Are the Benefits of Buying a Car?
Like leasing, the option of buying a car has its pros and cons. We’ll start off by looking at the pluses of buying, financing, and owning a new vehicle.
Ownership
When you purchase a new car for cash, you own it outright, and you can do with it as you please. If you finance your purchase, its title will be held by your lender until any auto loan is paid off, though you’ll build a bit of equity with each month’s car payment as long as the payments outpace the rate that the car depreciates. Lease customers never have equity in their vehicles.
Unlimited Mileage
Leases come with mileage restrictions, but when you own a car, you can drive it as much as you want. If you drive a lot of miles, buying a car makes much more financial sense than leasing one. You can also drive a car as little as you want, preserving its value.
Beyond fuel and maintenance costs, there’s no additional charge to drive your car mile after mile.
Cash For Your Next Car
You can use any equity that you have in a vehicle toward a down payment on your next ride. For example, if your current car is paid off and worth $10,000, you can trade it in and put that $10,000 of value toward the cost of a new car. You can’t do that with a leased car.
If you have a loan, you’ll need to pay it off before you know how much equity you have to apply to your next purchase. To maximize the amount that you get from your trade-in, you may want to explore other ways to sell it, rather than just trading it in at the dealership when you buy a new car.
You Can Make It Your Own
Want to paint your Mazda Miata pink and give it purple wheels? You can’t do that with a leased car unless you want to pay a ton of money at the end of the lease. If you own the vehicle, you can customize to your heart’s content. If your changes add value to the car (which painting your Miata pink won’t do), you’ll enjoy a return on your investment when you sell the car.
No More Payments When Your Loan Is Paid Off
A significant advantage of car ownership is that your monthly payments end when you pay off your loan. If you have a four-year auto loan and you keep your pickup truck for seven years, you’ll have three years with no monthly car payments. Every month that you have a leased vehicle, you will have a payment.
The money that you’re not paying each month can cover any repair or maintenance costs, or you can save it for use as a down payment on your next car. Some experts recommend continuing to make your monthly payments into a savings account. By doing so, you essentially pre-finance your next vehicle and earn interest along the way.
You Can Sell Your Car Whenever You Want
When you sign a lease contract, you’re usually locked into that lease for the duration of its term. When you own your car, you can keep it for as long as you want. If you find out that it doesn’t fit your lifestyle after a year, you can sell it. Find a car that’s reliable, and efficient, and perfect for your family, and you can end up keeping it for a decade.
It’s Easier to Finance Than to Lease
Leasing favors consumers with fantastic credit scores, and there are few leasing options available to customers with lousy credit. Although a car loan usually costs more than a lease, a car loan is easier to secure for those with bad credit.
To get the best financing deal, you’ll want to check with several lenders and have a pre-approved financing deal in place before you get anywhere near a car dealership. A dealer may be able to find financing that beats your offer, but they won’t do so unless they know that they have to fight for your business.
You Can Refinance Your Loan
You can refinance your loan at any time during its term. You’ll potentially save money by lowering your interest rate, reducing the size of your monthly payment, or changing the number of months you have to pay. Buyers who had bad credit when they initially took out their auto loan can save a significant amount of cash by refinancing a year or two down the road from when they first took out their car loan.
According to credit reporting agency TransUnion, consumers lower their interest rate an average of 2.4 percent when they refinance.
What Are the Drawbacks of Buying a Car?
Along with its benefits, buying a car has several drawbacks. We’ll explore a few of them in this section.
More Expensive in the Short Term
Since you are paying for the entire car, buying is more expensive in the short term. Unless you make a huge down payment, your car payments will generally be significantly higher. You may be required to make a substantial down payment as well.
You can manage the size of your monthly loan payments by saving up for a large down payment and stretching the length of the loan out a bit. Be cautious about extending the loan out too far, however, as that can be a costly mistake. Generally, if you can’t buy a car with a six-year loan, you can’t afford the car.
You Pay Interest on the Entire Loan Balance
When you finance a car, you have to pay interest on the entire amount of money you borrow. With leasing, you’re only paying interest on the difference between the capitalized cost and the vehicle’s residual value.
Let’s use a $40,000 SUV as an example. Our car loan calculator shows that if you borrow the entire $40,000 for five years at 5 percent, you’ll pay $5,291 in interest. Lease the same SUV for three years, with a residual value of $25,000 plus a money factor equivalent to 5 percent, and you’ll be essentially financing $15,000 for three years. Using the auto loan calculator, you’ll find that you’re only paying $1,184 in interest (though there will likely also be some fees on the lease).
You May Pay Much More Sales Tax
Depending on where you buy or lease, you can potentially be liable for much more sales tax when you buy compared to when you lease. In most places, you only pay tax on the amount due and the monthly lease payments. When you buy, you have to pay tax on the entire cost of the vehicle (less your trade in most states).
It’s best to talk to a tax advisor who knows your specific financial circumstances before making a car lease-versus-buy decision based on tax consequences.
Buying Often Requires a Down Payment
If you want the best financing terms when you buy a car, you’ll need to make a significant upfront payment. When you make a sizeable down payment, it lowers your loan-to-value ratio and makes your car loan less risky to a financial institution or other lender. If you have good credit, it’s relatively easy to negotiate a lease with nothing due at signing and somewhat higher monthly payments.
You Don’t Know How Much the Car Will Be Worth
There’s no way to know exactly what your car’s resale value will be when you decide to sell it. While you might be able to have a rough long-term estimate, market and economic forces can have a significant impact on its value. If you buy a car that gets a bad reputation for reliability, for example, it can lose its resale value much faster than its competitors. On the other side of the coin, if you buy a car that’s popular and reliable for the long run, it could be worth more money than predicted when it comes time to sell.
Its Warranty Will Run Out
With most leases, you’ll have full warranty coverage during the entire term of the contract. New-car bumper-to-bumper and powertrain warranties vary in length, but there’s a good chance that if you buy a car, your warranty will expire before you decide to sell. That leaves you exposed to repairs that you’ll have to pay for out of pocket if the car is no longer covered.
You can mitigate this risk by looking for cars that have high predicted reliability ratings and those that come with long warranties.
How Do You Buy a Car?
There are two significant components to think of when starting your quest for a new car: choosing the right vehicle and getting the best financing deal you can find. Our new car rankings can help you with the first part by showing you which models outshine their peers based on the consensus views of America’s top automotive journalists, plus quantitative data on predicted reliability and safety.
The best route to affordable financing requires you to apply for a pre-approved loan well before your car shopping starts and definitely before you visit a car dealer. Banks, credit unions, and other lenders will look at your credit score and a host of other factors such as your income and monthly rent. Once you have preapproval for a loan, a dealer may be able to beat their total cost of financing, but they can’t compete with an offer you don’t have. When two lenders compete over who gets your business, you have a better chance of getting a lower rate than simply taking what the dealership’s financing manager offers you.
You’ll want to see if there are any incentives on the car that you are considering. You can easily do that by exploring our new car deals page, where we track the best offers that automakers have available. By taking advantage of a low-interest financing deal or a large cash back offer, you can save thousands of dollars.
When you visit a dealer, you’ll want to take a test drive in the specific vehicle that you are looking to buy, not just a similar model. Then your task is to focus on negotiating the best price you can for the car. The dealer will want to merge the discussion about the cost of the car, your trade-in, and financing into one conversation. Instead, you want to deal with each as a separate discussion to keep all of the numbers clear.
You want to have a strict car-buying budget in place that is not solely based on a monthly payment. Car dealers are skilled at working the numbers to hit your monthly payment goal while extending the loan term and stuffing the deal with costly extras. We’ll show you how to figure out the total cost of the car a bit later, but for now, just know that buying on monthly payment alone is not a good way to buy a vehicle.
When you have a deal in place, be sure to read every piece of paper you are asked to sign. You want to make sure that the numbers are accurate, complete, and that they match up to what you agreed to. If there are blank spaces or incorrect information, insist that they are filled in or corrected before you sign. Never sign a document with incomplete or inaccurate information on it, as it can be tough to correct a contract with your signature on the dotted line.
How Do You Lease a Car?
Leasing a new car is similar to buying a car in many ways. That includes haggling over the price of the vehicle, which is something many lease customers don’t realize they can do. Like with car buying, you’ll want to keep the discussion of your previous lease return, any trade-in, and the price of the new car separate.
Be sure to visit our lease deals page to see the best incentives that automakers are offering on leases. Lease deals can lower your monthly payment, the amount due at signing, or both. Don’t assume that an advertised lease is a good deal. We’ll show you how to figure out the total cost of a lease in a moment.
Lease documents can be incredibly complicated. Of course, you should not sign any materials that you don’t completely understand, which means you may want to run them by an attorney or tax professional before you sign them. If the dealer pressures you to sign something you can’t figure out, it’s a good time to slow the process down and be prepared to walk away.
Before you leave the dealership in your newly leased car, it’s a good idea to have gap insurance in place – in fact, many leases require it. It’s a good idea to talk to your car insurance agent before you go to the dealership. That way, you can compare their offer to the dealer’s offer and pick the best option.
Figuring Out the True Cost of Your Car
The best way to compare car deals is to figure out the total cost of the lease or loan. Fortunately, it’s pretty easy to do both.
To determine the total cost of most leases, you multiply the monthly payment by one less than the number of months in the term of the contract and then add the amount due at signing. You subtract one from the number of months because the first payment is usually included in the amount due at signing. This isn’t always the case, so check the terms of the lease to be sure.
Let’s look at an example. You’ve found a lease on a subcompact SUV, with payments of $200 per month for three years with $2,000 due at signing. Multiply the $200 payment by 35 (36 months minus one) and add $2,000. The total cost of the lease would be $9,000, plus any fees and taxes.
Figuring out the total cost of buying a car is a little more complicated because it requires you to use a car payment calculator to determine the monthly payment. To find the total cost, you’d multiply the monthly payment by the number of months in the lease, then add the amount of your down payment.
For this example, we’ll say that you found a compact SUV and negotiated a price of $30,000. You’d pay $5,000 down and finance the remaining $25,000 at an interest rate of 5 percent for five years. Our auto loan calculator shows that each monthly payment will be $472. The total cost of the loan is $472 multiplied by 60, plus the $5,000 down payment, which equals $33,320.
It is crucial that you do the math yourself on any car deal that you are considering. Leaving the numbers to the salesperson or finance office leaves too much of a chance for them to manipulate the math and lead you into the deal that they want you to accept. Just opening the calculator app on your phone sends the message that you are serious about understanding the agreement.
Can I Lease a Used Car?
Used car leasing is a growing, yet still small, segment of the leasing market. You can lease a used car, but there is more risk to the lessor, so the terms of used car leases are typically slanted to protect them. Not all dealers leased used cars. Even at those dealers who do, there might only be one or two people who understand how to write them.
Since you’re only paying for the depreciation that is expected during the time you have the car, and most of the depreciation will have occurred when the car was newer, used car leasing can be an excellent deal. The price difference may be big enough that you can shop for a luxury car, instead of the mainstream model you could afford if you bought new. Of course, older vehicle are more likely to need costly repairs during the lease, which may not be covered by a warranty.
Many of the used cars that you’ll find available for lease are manufacturer certified used cars. They will have undergone a comprehensive inspection at the dealership and will often come with some warranty coverage.
The Verdict
Which option you choose to get your next vehicle depends on your personal financial picture, how you use your car, and how long you plan to keep your vehicle. While there’s no one-size-fits-all answer, assessing what you want and need from your car, plus what makes the best financial sense will lead you to the proper choice.
Learn more about Ford Finance here
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Original article content courtesy of U.S. News
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