Leasing vs. Buying a Car: What to Know

You might be in a position where you know you’re ready to sell your current car for cash and then get a new one. If so, you could also be trying to determine whether it’s better given your financial and personal situation to lease or buy that new vehicle.

Below we’ll go over everything you should know as far as comparing leasing and buying, so you can make the best financial decision.

What is a Car Lease?

When you lease a car, it’s like a rental. You make an upfront payment and then monthly payments. In exchange for those payments, you use the car for a few years. When your lease ends, you return the vehicle. You can then decide whether you want to get a new lease or buy a car.

The lessor is the company that owns the car or will buy it. You would be the lessee, meaning you’re paying to borrow the vehicle.

When you lease a car, your monthly payment is calculated based on depreciation. Depreciation is a calculation of the change between the car’s current value and its value when the lease ends, plus additional fees and interest.

When you sign a lease agreement, it will include:

  • How much you pay at the beginning of the lease
  • The length of the lease, which often ranges from two to four years
  • How much the car is worth at the time you sign the lease
  • How much the vehicle will be worth at the end of your lease
  • Any fees you’ll be responsible for paying when your lease ends
  • The money factor, which is also called a rent charge and is somewhat like an interest rate on a car loan
  • Termination fees if you decide to return the car before your lease is up
  • How many miles you can drive annually—most leases allow 10,000 to 15,000 miles a year. If you go beyond that, you may have to pay a fee.
  • The consequences of missing a payment on your lease.
  • The definition of normal wear and tear and what you’re responsible for paying if the wear and tear are excessive.

How Do You Lease a Car?

If you’re thinking about leasing a car, you’ll need to check your credit to see if you’re even likely to qualify. You’ll also have to calculate how much you can afford to put down and then pay every month. Don’t forget additional expenses in your budget like your insurance, registration and gas.

Once you have those financial elements in place, you can start to test drive cars and see what might meet your needs.

If you’re thinking about trading a car, you can find its fair market value and ensure you’re going to have enough to pay off the balance on your existing loan, if applicable. It tends to be a better financial decision to sell your car on your own and then use that money as a lease down payment.

When you’re leasing a car, something to think about that you don’t necessarily have to consider when you buy are your driving habits and how you think you’re going to use the car.

Just like buying a car, when you’re leasing, you need to shop around for the best terms. Good terms on a lease include a low down payment, minimal fees and affordable monthly payments.

When you sign a lease, make sure you read the agreement in detail to make sure it actually has in it what the dealer promised you when you were negotiating.

How Are Lease Payments Determined?

When you get a car loan, payments are calculated based on the sale price, interest rate, and the number of months you’re going to have to repay your loan.

Lease payments are calculated based on:

  • Sale price which you can negotiate with the dealer, similar to what you would do if you were buying a car
  • The length of the lease, which is the number of months you agree to lease the vehicle
  • The expected mileage—most leases come with 10,000 miles a year
  • The residual value is the vehicle’s value at the end of the lease, with depreciation figured in. If you want to purchase the car after your lease expires, this is what you pay.
  • The rent charge, as mentioned, is like interest.
  • Taxes and fees do affect your monthly lease payment too.

A dealer may require a down payment or leave it up to you but the bigger your down payment the lower your monthly payment.

You have to remember, while a down payment may reduce your monthly payments, it doesn’t make a much financial sense to put a lot of cash toward something you’re going to give back to the dealer.

The Benefits of Leasing

There are a lot of ways leasing a vehicle may have more appeal to you than buying. For example, your monthly payments will probably be lower because you don’t have to pay back the principal. You’re borrowing and then ultimately repaying the difference in the vehicle’s value when it’s new and the residual, which is the value that’s expected when the lease ends.

Specific benefits of leasing a vehicle include:

  • You’re driving the car when it’s in peak condition, and you’re less likely to deal with any maintenance issues.
  • You’re going to be driving a late-model vehicle, so that means the new-car warranty from the manufacturer typically covers it.
  • As part of the lease, you may get free scheduled maintenance and oil changes.
  • You may be able to drive a more high-end luxury vehicle than you’d be able to afford in other circumstances.
  • Since you’re driving a late-model, you’ll have the most advanced safety features.
  • You don’t have to think about selling the vehicle when you want a new one.
  • There may be tax advantages if you’re a business owner.

What about the downsides of leasing?

There are certainly some to consider, including:

  • When you lease, you’re going to end up spending more than an equivalent loan because you’re paying for the vehicle during the period of its fastest depreciation.
  • If you always lease, you’re always making monthly payments. When you buy, on the other hand, you can keep the vehicle long after you stop making payments so you get more value from it. When you look at the long-term, the cheapest way to drive a vehicle is purchasing a car and then keeping it until needed repairs would be more than the value of the car.
  • The mile limitation can be a big downside for some people thinking about leasing. If you have to pay an excess mileage penalty, it can range from 10 cents to as high as 50 cents per mile.
  • If you don’t keep the car in good shape, you’re going to have to pay for excess wear and tear.
  • When you lease a car, if you want to get out of early for any reason, you may have to pay penalties and early termination fees all at once, out of pocket.
  • You still have to pay for things like tires if something happens.

When Is Leasing Better Than Buying?

There isn’t one answer that fits everyone as far as whether it’s better to lease or buy. It really depends on your particular situation. For example, if your biggest concern is monthly payments, leasing may be better for you.

You might also prefer to have a new car every few years or not have to worry so much about maintenance.

For other people, these aren’t priorities at all.

What To Know About Buying a Car From a Dealership

If you’re comparing a lease to buying from a dealership, what should you know?

Before going to a dealership, you should have already done the research. You should know about the dealership itself, your financial situation and the vehicles on your shortlist.

If you go into a dealership without having done your research ahead of time, there’s a high likelihood you can get talked into buying a car that isn’t what you want or is more than you can afford.

There are some things you need to bring to a dealership if you plan to buy a car including:

  • Driver’s license
  • Title and registration for your trade-in if relevant
  • Proof of income
  • Insurance proof
  • Proof of residence, like your utility bill
  • Employment verification, such as a pay stub that’s relatively recent

Overall, if you’re thinking about leasing a car, it tends to work best if you’re someone who wants to have a new car every few years. If that’s a priority for you and you buy a car, you will be paying a lot in finance charges compared with the principal.

You could end up financing a new car and the remainder of your old car.

You might also like the idea of leasing if you don’t want to deal with a lot of maintenance issues and you want a low monthly payment.

Otherwise, if you don’t fall into these categories, financing a car with a traditional loan could be more advantageous.

Infographic created by O’brien Toyota

Author: Brandon Park