What should I know about the differences between leasing and buying a vehicle?
You do not own a leased vehicle and you are required to return the vehicle after the lease ends unless you exercise a purchase option.
Below are some of the factors in buying and leasing to help you compare your choices.
Leasing a vehicle:
- Monthly payments may be lower than buying but the payments are going towards the depreciation of the vehicle during the lease term plus rent charges (similar to interest on a loan) and other fees.
- You may be responsible for early termination charges if you end the lease early. These fees can be very expensive. You will not be able to 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.
- For most leases, the company or person leasing the vehicle to you assumes the risk of depreciation.
- Most leases include mileage restrictions of 10,000-15,000 miles per year. At the end of the lease, most leases also include fees for excessive mileage and wear and tear. The amount of excessive wear and tear is usually determined by the lessor.
- A typical lease is 2-4 years.
Buying a vehicle:
- Monthly payments may be higher than leasing but part of each payment is going towards the purchase price of the vehicle.
- You might sell or trade-in the vehicle when you want to purchase a new one.
- You assume the risk of depreciation to your vehicle in regards to what it will be worth when you decide to sell or trade it in.
- You can drive as many miles as you want. High mileage and excessive wear and tear will affect the vehicle’s resale value.
- A typical auto loan term is 4 to 6 years.
- You own the vehicle and get to keep it at the end of the financing term.
If you decide to lease, you can and should negotiate the lease terms. You can compare different lease offers with the goal of negotiating terms such as the:
- Cost of the vehicle;
- Amount of any down payment or trade-in;
- Rent charge;
- Mileage limit, and
- Purchase option.
Just as an auto loan is complicated, so is an auto lease. With a standard lease the majority of the monthly payment is the amount the vehicle will depreciate over the lease term plus a rent charge. The steps involved in calculating the monthly lease payment are generally as follows:
You and the leasing company decide on the cost of the vehicle minus any trade-in, down payment, or rebate. For example, $20,000.
- You decide on the lease term, typically 2-4 years. For example, 3 years/36 months.
- The leasing company will determine 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 will be 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 equals $333.
Note: If your lease includes a purchase option, you will want to consider how accurate the residual value estimate is because that residual value amount is often the purchase option price.
You should carefully review the vehicle lease document and terms. For more information about leasing, see the Federal Reserve publication “Keys to Vehicle Leasing. ”