Your old car has finally stopped working and you need new wheels. Or maybe you just want to upgrade to a newer model. Or your family is growing and it’s time to trade in the coupe for something more practical. What is your best option? Should you buy a car, or would it be better to lease a car?
There is no easy answer to this question; it depends on your situation. The criteria that determine whether you should lease or buy your next car are largely based on how you plan to use it. For example, are you looking for a personal vehicle, a family car, or a car for business? How much driving do you plan to do? Do you have a long commute? Can you accommodate monthly lease or car payments in your monthly budget?
Perhaps the new car you have your eye on is out of your price range. It used to be common practice to lease more expensive cars, although these days you'll find small SUVs and even compact cars are easier to lease. Leasing can help you upgrade your ride, but it may be more expensive than buying in the long run. And you can only have a leased car for a specified time, so you don’t get the satisfaction that comes with owning your car. For these reasons, you might prefer to take out a loan and buy a car instead.
These are just some of the factors you have to balance when considering whether to buy or lease your next car. In this blog post, we will weigh the pros and cons of leasing versus buying a new car to help you make the best decision.
Understanding How Leasing Differs from Buying
Before you can decide whether to lease or buy your next car, you need to understand exactly how a car lease works.
Think of a car lease as an extended car rental. You usually lease the car for from 36-48 months, but you never actually own the car. You still have to make a down payment and monthly payments, just as if you would with a car loan. At the end of the lease, you can either return the car to the dealer or buy the car for the amount agreed upon in the original lease contract.
One of the primary differences of leasing versus buying a new car is that lease payments are very different from car payments. With a lease payment, you are paying the dealer for the privilege of driving their car. When you make car loan payments, a portion of each payment goes toward the purchase of the car, and once you have made your last loan payment, the car is yours.
Because you are only renting a car from the dealer with a lease, you also have to pay wear and tear and appreciation on the car at the end of the lease period. If the car has dents, scratches or dings, or you were in an accident while driving the car, then the depreciation costs can add up.
Leasing Has Its Own Terms
If you plan to lease a car, you will need to understand an entirely different vocabulary than if you were buying a car.
First, there is a capitalized cost, also known as cap cost, which is the actual price of the car. If you're leasing, you can attempt to negotiate on the price; however, with most automotive-sponsored lease deals, the price is fixed.
Then you need to consider residual value. The residual value is the assessed value of the vehicle at the end of the lease term. The higher the residual value as a percentage of the vehicle's cap cost, the better it is for you. A lower residual value forces you to pay more for the car's capitalized cost.
Of course, different cars depreciate at different rates. If you plan to lease, look for a deal on a car that will depreciate the least and have high residual value.
Now you can determine exactly what you pay when you lease a car. Your out-of-pocket expenses are the capital cost of the car minus its residual value. For example, if a Mercedes SUV has a capital cost of $50,000, and the residual value after three years is $30,000, then you will end up paying the difference of $20,000 plus fees, interest, and depreciation. However, you don't get anything for that $20,000—except the privilege of driving a Mercedes SUV for three years.
Now that you have a basic understanding of how leasing works, let's take a closer look at the pros and cons of leasing versus buying a car.
The Pros and Cons of Leasing
There are many advantages to leasing a car. That's why 4.3 million Americans turned in leased cars in 2019. Here are just a few of the advantages of leasing:
- Less money down: Because you aren't buying the car, you ma not need as big a down payment. If your credit is good, you may be able to lease a car with no down payment at all.
- Lower monthly payments: Normally, monthly lease payments will be less than loan payments.
- You get a warranty: New cars come with a manufacturer's warranty whether you lease or buy, so you don't have to worry about excessive service costs for the first 10,000 miles or more.
- You can get more car for your money: Because the down payment and payments are lower, many people opt for a more expensive car.
- You can drive a new car every few years: If leasing a car is right for you, you can turn in your car every few years and get a new car with a new lease.
- You get business tax benefits: If you lease your car for business, research. You may be able to deduct depreciation and finance charges from your monthly lease payments.
Of course, there are downsides to leasing a car as well:
- You never own the car: No matter how long the lease, the dealer is always the owner of the car. You are only allowed to use the car for the duration of the lease, although you have the option of purchasing the car once the lease is up.
- Your insurance costs are higher: Whether you lease or own a car, you still need to carry car insurance. With a leased car, you may be required to carry more comprehensive insurance, including collision coverage, which means higher insurance premiums.
- You need to watch your mileage: Every car lease has a mileage limit, and exceeding the limit can be very expensive because additional fees are charged by the mile. If you plan to drive the car quite a bit, you might consider a high-mileage lease.
- Costs for cosmetic damage: No matter how careful you are, you're likely to get dents and scrapes on your leased car. When you turn in your car, it will be assessed for excessive wear and damage to tires, bumpers, glass, wheels, paint, upholstery, and so on, and you will be charged accordingly.
- Additional fees: When you lease a car, you incur fees that you wouldn’t with a car loan. There is a rent charge, which is charged as a flat rate rather than a percentage, and taxes and fees are added to the monthly lease cost.
The Pros and Cons of Buying
- Pride of ownership: If you decide to buy a car, it’s yours. You own it, which means you don’t have to worry about wear and tear or coffee stains on the seats. Additionally, you can customize the car as you wish, whether you want to give it a new paint job or upgrade the speaker system.
- You can sell the car: Once you buy a car, it is yours to sell. If you need to trade it in for a larger car or a less expensive car—or if you just get tired of it—you're free to do so.
- Lower insurance rates: You may have more control over car insurance. In many cases, you don't have to pay extra for collision and comprehensive coverage, as you do with a leased car.
- No mileage limitations: You don't have to worry about exceeding a mileage limit while driving a car you own.
- Extended warranty options: New cars and some used cars come with a warranty. If you buy the car, then you can also buy an extended warranty when the dealer warranty expires.
Of course, there are also disadvantages to buying a car:
- A larger down payment: Depending on the car you buy, you may need to come up with a down payment. If you want a new car, the down payment will most likely be larger than if you plan to buy a used car.
- Higher monthly payments: Very few people can afford to pay cash for a car, so if you need to take out a car loan, your monthly payments likely will be higher than if you lease. If you plan to use the car for business, that can give you some tax advantages.
- Depreciation: Any car depreciates. If you own your car, then the resale value is unknown, whereas the valuation of a leased car is negotiated up front.
- Repairs: Once the warranty expires, any repairs are your responsibility.
So is it better to buy or lease? Now that you appreciate the basic differences, it’s easier to weigh the options.
For example, if you don’t drive very much, use your car for business, are a good driver, and don’t care about car ownership, then leasing a car may be right for you. If you tend to keep a car for a long time and don’t care about mileage or depreciation, then buying a car may be more practical.
You also have to consider how much you want to pay over the life of the car. In general, leasing a car will be more expensive in the long run because you never assume ownership of the car, which means you cannot sell or trade it. However, if you have a limited monthly budget, then leasing a car could be easier on your wallet. When you buy a car, you will probably spend less overall, including repairs and depreciation, especially if you plan to keep it for more than a few years.
How to Pay for a Car
As with any major capital expense, you should take a hard look at your budget before you go car shopping.
Consider all the expenses that go with acquiring a new car. Calculate your monthly car payments or lease payments and see if they'll fit within your household budget. Research what your monthly insurance costs are likely to be. Try to think of all the expenses related to car ownership and see how they fit in your household budget.
How much money you put down on a car and whether you lease or purchase will affect your monthly payments. If you need to lower your monthly car payments, consider saving more money for a down payment before you buy or lease. When calculating car costs, don't forget to add in fees for taxes, auto registration, delivery fees, and so on.
If you lease a car, fees and rates are determined by the dealership. Buying a car gives you more control over the interest rates you're likely to pay. Be sure to shop for the best auto loan interest rates. You can get an auto loan from a dealership or a bank, but credit unions have very favorable auto loan rates.
iQ Credit Union can help you with your next car purchase. You can prequalify for an auto loan to determine how much you can borrow and what the monthly payments will look like for your next car. insureQ can give you auto insurance quotes, and you can use our loan calculator to help you determine your monthly payments. And, as a member of iQ Credit Union, you can take advantage of our AutoSMART car buying service to help you find the right dealer or automobile.
Shopping for a new car can be a stressful experience, but at iQ Credit Union, we do everything we can to make the process painless. After all, buying or leasing a new car should be an exciting and fun time!