Your Next Car: Lease Or Buy?
What are the pros and cons of each when it comes to your next car? Here's what you need to think about ..
Shopping for a car is a lot more fun than figuring out the best way to pay for it.
When you have settled on a make, model, features and color, then come the financial decisions: Should you lease? Should you buy? Where should you get a loan, and how long should it last?
A further wrinkle is that lately rising interest rates have made paying in full using cash a good option. But if you can’t afford to buy a car in cash - and most people can’t - you can either lease one or take out a loan to buy it. How do you decide which is best for you?
What is the difference between buying with a loan and leasing?
When you take out a loan, you are borrowing money to buy a car and then paying it back over time, with interest. At the end of the loan term, you own the car free and clear.
With a lease, you are essentially renting a car. At the end of the lease term, you have the option to either buy the car or give it back.
About 78% of people who get a car buy it in cash or with a loan, according to the online car-shopping guide, Edmunds. The remaining 22% leased theirs, down from about 30% three years earlier, when automakers were subsidizing leases more heavily.
Should I buy or lease?
Buying offers several advantages, including control over the duration of ownership, discretion to use and customize and the potential to protect the value of the asset and ultimately sell/trade.
Disadvantages of buying include sunk costs, heavy depreciation, the responsibility for repairs (potentially beyond the warranty) and the hassle of trading-in or selling which can be made even more difficult by the fact the years-old vehicle you are trying to sell may lack many of the technology features that potential car buyers expect as standard at that time. This resale issue is becoming more and more significant as the pace of improved technology in cars is accelerating quickly.
Leasing offers several advantages, including a short-term commitment, warranty coverage, and temporary use of a depreciable asset. Another benefit of leasing is that you are able to get a new car every few years. Some people prefer that because they like having the latest technology and safety features, and dislike dealing with the maintenance issues that arise later in a car’s life.
The main disadvantage of leasing is that you don’t own the car when the lease is up and the total costs over time may be higher than with ownership. This can be especially true if you choose to buy out your lease at the end of the term Also, leasing is not a good option for people who put a lot of miles on their car each year, since leases come with mileage limits and increasing those default limits comes at a cost, as does breaking them (see below).
In addition to the purely financial considerations, the answer to this question has to do with whether you even want to own the car outright, given your particular situation, location and lifestyle. What exactly is going to be the primary use for the vehicle? The longer you expect to keep it, the more likely it is that you should buy it. Put crudely, if you are going to marry your car, then it may be best to buy it. If you only want to date it, leasing it may be the best plan.
What are the specifics of a loan that I should pay attention to?
The specifics of a loan dictate how much it will cost you in total, as well as each month, so it helps to understand where those numbers are coming from.
Monthly payment: This is how much money you will owe each month as you pay off the loan. As you figure out what monthly payment you can afford, don’t forget to factor in the considerable additional costs of insurance, gas and maintenance. If you later fail to make your monthly payments, the car might get repossessed and your credit score will likely get badly hurt.
Annual percentage rate, or APR: This percentage refers to the interest you pay on the money you borrowed.
Term length: This is how long you will have to keep making monthly payments and is typically a number of months that is a multiple of 12, such as 48 or 60. Shorter term lengths usually come with lower APRs.
Total cost: To compare loans, look at how much each one would have you pay over the course of the loan term, including interest. While a lower total cost and shorter time frame may seem ideal, you need to make make sure that you can afford the monthly payment that comes with it. A longer term might make the monthly payment more affordable, but could increase the total cost of the loan.
Down payment: Many contracts require you to put down some amount of cash as a condition of being offered the loan. A typical down payment is about 15% of the purchase price, according to Edmunds. Putting money down will reduce the amount you pay in interest over the life of the loan and might get you a better APR.
Where should I get a loan?
It is best to shop around at banks and dealerships.
In October 2023, the average APR was 7.6% for a new car and 11.6% for a used car, according to Edmunds. The rate you get will vary, however, based on your credit score.
It is wise to gather that information before you visit a dealership so that you have a baseline to compare to. Starting by checking the rates at your bank or credit union before stepping into a dealership.
Dealerships can also arrange a loan for you, which they do through an auto-maker’s financing arm or an arrangement they have with a bank. Sometimes dealers might offer promotional rates that undercut the APRs you will get elsewhere.
These can be a great deal, but might only be available on particular vehicle models that the dealership is maybe trying to shift. Even if you don’t get a promotional rate, always ask a dealership if it can beat a rate that you may have found elsewhere.
What are the specifics of a lease that I should pay attention to?
Most important, of course, is making sure that you can afford the recurring payments that come with a lease. But you should also understand the costs that come with it and the decision you will face when the lease ends.
Monthly payment: Just like with a loan, you will want to make sure that the amount you will pay each month is something you can afford. You will be responsible for these payments until the lease period ends, even if you want to return the car early. Leases can sometimes, but not always, require a down payment.
Option to buy: Most leases will give you the option to purchase the car when the term is up. Remember that you will have to pay sales tax on the transaction at the time.
Residual value: A vehicle’s value falls over time, and the residual value specifies how much it will be worth when the lease is up. This number is important to note if you are considering buying the car at the end of the contract. The more a car’s value depreciates while you lease it, the higher your monthly payments could be.
Money factor: This number is essentially the interest rate you will pay during the lease. It might not seem like you are paying interest during a lease, but a part of your lease payment takes account of the value that the vehicle loses while you drive it and the interest you pay on that value. To convert the money factor into a number you will recognize, multiply it by 2,400, which effectively converts it to an APR. For example, a money factor of 0.0025 translates to an APR of 6%.
Mileage limits: Leases include limits on how many miles you are allowed to put on the car while you have it. You should ensure that your annual driving will keep you under that limit. If it won’t, it’s cheaper to add more miles at the beginning of the contract than to turn the vehicle in with the limit exceeded. Conversely, for those who will have a low mileage number, you might be able to lower your monthly payment by requesting a lower limit.
Fees: A lease contract might include fees that you should factor into the cost of the vehicle, including ones for turning the car in at the end of the lease, buying it at the end of the lease, or returning it in poor condition.
See the attached checklist below:
Sources include The Wall Street Journal and Edmunds.
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