What should I know about leasing versus buying a car?
Buying a car means that you own the vehicle once your payments have been made. A lease is an agreement to use a vehicle, new or used, for a certain number of months and miles.
Choosing whether to buy a car or lease can be an important financial decision. The most important factor to consider is that leasing is like renting, and your payments won’t go towards owning the car, unless there’s an option to purchase it. Instead, you’ll need to return the car once the lease ends.
To help you choose the best option for you, here are some of the key factors in buying vs. leasing a car.
Buying a vehicle
- Your monthly payments for a loan may be higher than leasing, but your payment goes toward paying down your loan and equity in the vehicle.
- You have the option to sell or trade in the vehicle when you want to purchase a new one.
- You can drive as many miles as you want, but high mileage and excessive wear and tear affects the vehicle’s resale value.
- A typical auto loan term ranges from 3-7 years.
- You own the vehicle and get to keep it at the end of the loan term.
Leasing a vehicle
- Your monthly payments may be lower than buying, but the payments are going towards depreciation of the vehicle during the lease term plus rental charges.
- You may be responsible for early termination charges if you end the lease early. These fees can be very expensive. You can’t simply return the vehicle and stop making payments.
- At the end of your lease term, you can either turn the vehicle in and pay any end-of-lease fees or purchase the vehicle if your lease includes a purchase option.
- Most leases restrict your mileage to 10,000-15,000 miles per year, and they may also include fees for excessive mileage and for wear and tear at the end of the agreement. What's considered excessive wear and tear is usually determined by the leasing company.
- A typical lease is two to four years.
Negotiating your lease terms
You can get a better deal if you compare several leasing offers and negotiate your terms. Lease terms are negotiable, and the most common items consumers negotiate include:
- The cost of the vehicle
- The estimated value of the car at the end of the lease, also called the residual value. This is what you will pay for the car if a purchase option is included.
- Amount of a down payment
- Value of the trade-in of your current vehicle
- Rental charge or money factor
- Mileage limit
- Purchase option
Calculating your lease payment
With a standard lease, most of your monthly payment goes towards the amount that the vehicle depreciates over the lease term. You also pay a monthly fee to the lender for renting the vehicle.
Here are the steps commonly involved in calculating the monthly lease payment:
- You and the leasing company negotiate the cost of the vehicle minus any trade-in, down payment, or rebate. For example, $20,000.
- You decide on the lease term, typically two to four years. For example, three years is 36 months.
- The leasing company determines what the vehicle will be worth at the end of the lease, known as the “residual value.” For example, $8,000 is the residual value.
- The amount of depreciation is calculated by subtracting the residual value. For example, $20,000-$8,000=$12,000 of depreciation.
- The monthly payment is calculated by adding the estimated amount of depreciation during your term plus the rent charge, taxes and fees, and dividing that amount by the number of months in the lease term. For example, $12,000 divided by 36 months = $333.
You should question how accurate the residual value estimate is because that value is used to determine the monthly payment and also the amount you pay if you decide to purchase the vehicle at the end of the lease.
Leasing from “Lease Here, Pay Here” dealerships
Similar to “Buy Here, Pay Here” dealerships, “Lease Here, Pay Here” dealers lease older used vehicles to people with poor or no credit who often need quick access to a vehicle. Common features of these leases may be weekly or bi-weekly payments and high rental charges. If the vehicle breaks down, you may be responsible for repairs. The lease will also most likely not include any option to purchase the vehicle at the end of the lease.
Before leasing any vehicle, review the vehicle lease document and terms clearly to determine if you’ll be able to afford the payments into the future and if it’s the right deal for you. You should also ask if the vehicle is equipped with a device that shuts down the ignition if you miss a lease payment or a GPS location device.
Know before you shop
There are several important financial decisions to make before you shop for a car. Learn what questions to ask so you can make the best choice for you.