Leasing vs. Buying a New Car
When it comes to buying a new car, you have three options: purchasing it with cash, purchasing it through a loan (also known as financing) or leasing it. For most shoppers, the decision comes down to buying or leasing.
To Lease or To Finance: That is the Question!
On the surface, the differences between leasing and buying a vehicle seem fairly straightforward. Leasing a car means you’ll usually have access to a new set of wheels every few years; buying it likely means that you plan to drive the same car for a much longer period of time. Leasing usually includes a warranty that covers most of your repairs; buying means accepting larger repair costs, which are inevitable as the car ages. Leasing agreements can limit your mileage and your ability to customize your ride; buying means you can put as many miles as you want on the car and customize it however you’d like.
Looking only at the comparisons above, you might conclude that buying a car is a more practical and economical option than leasing a car—but if that’s really the case, why are monthly lease payments so much lower (often 40% lower!) than monthly loan payments? Why is leasing considered more expensive in the long term if you’re paying less on a month-to-month basis? To answer these questions, let’s take a look at the concept of depreciation.
Depreciation means a loss of value over time. New cars are a textbook example—you’ve likely heard that a car loses thousands of dollars in value the moment you drive it off the lot. That’s accurate, and that’s depreciation at work (and yes, it can be kind of depressing).
All cars depreciate in value over time, but the steepest drop happens in the first three to five years, as you can see below:
– Brand new to 5 years old—the car depreciates by 15% to 20% of its value each year
– From 5 years to 10 years—the rate of depreciation slows slightly to 10% to 15% of its value each year
– 10+ years—the rate of depreciation tends to level out to less than 5% a year. By this time, the car is usually worth less than one-fifth of its retail price!
Depreciation takes its toll on the value of every vehicle. However, your decision to lease or buy will have an effect on how that depreciation influences your finances.
When you finance a car, you own it once you pay off the loan. This means that you personally take the hit on its depreciation, but it also means you also “own” its residual value. Although that value depreciates over time, if there comes a time when you’re ready to sell it or trade it in, you get the benefit of that resale or trade-in value.
By contrast, when you lease a car, you never actually own it. The company that leases the car to you is responsible for selling the car once you’ve completed your lease term. The leasing company also ultimately deals with the car’s depreciation in value. You get to drive a brand new car without needing to think about its loss in value. That sounds pretty great, right? In reality, even though the leasing company deals with the eventual sale of the car, you’re the one who makes up for its loss in value through your monthly payments. That payment includes an estimate of how much the car will depreciate by the time your term is up. Monthly payments are lower because you’re not paying for the entire car—you’re just paying for how much the car will depreciate in those few years that you’re driving it (a period of time when, coincidentally, the car depreciates the most).
When you finance a car, the monthly payments are higher because you are paying for the entire car, plus interest on the loan. When you pay the loan back, your monthly payments stop (unlike leasing payments, which continue as long as you’re still leasing) and even though your car will have depreciated in value by that point, you will own the remaining value.
As with any major financial decision, there are also other factors that come into play. You need to be realistic about your budget and honest about your lifestyle, and you need to figure out what’s most important to you as a new car owner. How comfortable are you with the limitations set by a lease agreement? How prepared are you to pay for eventual car repairs? Will driving a new car every two to three years be worth thousands of dollars more in the long run? To some people, it might be—it all depends on a combination of your personal needs and preferences.
Infographic Transcript: Leasing vs. Buying a New Car
Even though these cars are identical, the methods to pay for them are very different. The decision to lease or to buy a new car will have an impact on your finances as well as your lifestyle. Understanding the differences will help you make the best decision for you.
The basics of leasing
Leasing is sort of like renting a car for a fixed period of time. When you lease, you’re paying for the value of the car you use up during your term, plus interest. What’s left is known as the depreciated value of the vehicle.
• You lease a car for a fixed term—typically two to four years
• An initial deposit is often required
• You make monthly payments to continue using the vehicle
The basics of financing
Financing is buying a car through an auto loan. You can finance a car through the dealership or through a financial institution like your credit union.
• Loan terms can range from three to seven years
• An initial deposit is often required
• Your monthly payments go towards repaying the balance of the loan plus the interest
Pros and cons
• You don’t own the vehicle—you pay to use the vehicle during the term of the lease and must return it at the end of the lease unless you choose to purchase the vehicle
• A typical lease lasts half the time of a typical car loan—once the lease is up, you can move on to your next vehicle
• Depending on the terms of your lease, you can get a new car every two to four years
• You own the vehicle free and clear after your financial obligations are met—it will be yours to keep, sell or trade in on your next vehicle
• Like any tangible asset, a car’s value will decline over time due to general wear and tear plus the perception that as things age they become less valuable
• A typical vehicle will be worth about half of its sale price after four or five years—this decline in value is what you are paying for when you lease a vehicle
• A new car will depreciate an average of $3,400 per year during the financing term
• In the first year alone, the car will depreciate 15% to 20% and then it will lose 10% of its value annually
• Because you’re not buying the whole car, monthly payments are generally 30% to 60% lower when you lease
• Leasing can allow you to drive a car that could otherwise be out of your price range
• The average maximum monthly payment on a purchased car is $480, whereas most leases won’t cost more than $325 per month
• Monthly loan payments are higher because you are paying for the entire purchase price of the vehicle while also building your equity in the vehicle
• To lower your monthly payment, consider stretching out your loan term to 60 or 84 months or putting more money into the down payment
• A leased car can only be modified with approved accessories at the beginning of your lease
• New sound systems, exhaust systems or after-market engine tuning is taboo
• If you’re into cosmetic modifications or maximizing your car’s performance, you’ll be able to do whatever you want to your new car
• The typical mileage limit on a lease is 10,000 miles per year; however, most people drive at least 15,000 miles per year
• The terms of your lease will usually charge between 15 and 30 cents for every mile you go over the mileage limit per year
• Assuming you drive 15,000 miles per year, you could rack up a $1,500 fee per year when you turn in your leased car
• Mileage limits are not a problem—you can drive across the country if you want, as it’s your car
• However, as you put more miles on your car, the resale value decreases
Maintenance & west and tear
• Repairs and maintenance are usually covered in the lease—this can save the average car owner up to $1,200 a year in fees
• Since a leased car is a borrowed car, excessive wear and tear will be held against you and may cost you at the end of your lease
• You are on your own for maintenance costs, and they will rise as your vehicle ages
• There are no charges for vehicle wear and tear; however, excessive wear will lower the vehicle’s trade-in or resale value
Sources: Bankrate, Edmunds.com, LeaseCompare.com, LeaseGuide.com, MSN Money