So you are thinking about getting a new car. You have probably spent time thinking about the make, model, features, and everywhere you are going to drive it. But have you spent as much time thinking about whether you are going to buy or lease? You will likely have lower monthly payments if you lease, but isn’t buying supposed to be the more responsible thing to do? What to do depends upon your situation.
The Mechanics of Buying & Leasing
When you buy a car and finance the purchase, you are paying for the equity (ownership), depreciation (loss in value over time), and any interest on the loan. At the end of the loan’s term, you own the car. When you lease, you are only paying for the use of the car. The money you pay each month includes the car’s depreciation and interest, but not the equity portion. That is why lease payments are cheaper.
Let’s say you want to lease a car worth $30,000 and you want to lease for three years. Due to depreciation, the dealer expects the car to be worth $14,000 in three years. Your lease payments are based on the difference between what the car is worth today and what the car is worth at the end of the lease term, or $16,000. At the end of the lease, the dealer can resell the car for $14,000. Cars that retain more of their value, such as many more expensive cars, tend to be better lease deals.
Things To Be Aware of When You Lease
The value of the car at the end of the lease is called the residual value. Often, dealers will inflate the value to lower the total expected depreciation. This means there is a spread between what the dealer says the car will be worth from what what it will actually be worth. This spread makes payments more attractive and leads to better deals for the buyer. However, this spread can be problematic for the consumer if the car is wrecked. If a leased car is wrecked, the insurance company will pay what the car is actually worth…not what the dealer claims it is worth. If a car is only worth $12,000 but the dealer’s contract claims the residual value is $18,000, the consumer will owe the dealer the $6,000 difference. The solution to this problem is to make sure you have “gap insurance.”
Another to be aware of is cap cost reductions. Often, dealers will offer you the chance to make a large, one-time payment to reduce your monthly payments. This is usually done so that the monthly payments look smaller. But in reality, you are paying more than the monthly payment because of the cap cost reduction. Since you do not own the car, this down payment doesn’t go towards equity and you do not get that money back. Instead of paying a cap cost reduction, ask the dealer if you can make additional security deposits. Some dealers will allow you to “buy” a lower rate by giving them a larger security deposit. This will lower your monthly payment and the deposit should be returned when the car is turned in to the dealer.
The big key when leasing a car is to remember that you do not own it. You are renting the car from the dealer. So if you are thinking about any options such as a navigation system, media player, etc., remember that you are renting them. Do not pay the full cost because at the end of the lease, they will be returned along with the car.
When Is It Better to Buy and When Is It Better to Lease? A Few Questions to Ask
How many miles do you drive in a year? Lease agreements generally allow you to drive 10,000 – 15,000 miles per year. If you go over those limits, you will generally have to pay between 15 and 25 cents per mile. It is usually better to negotiate a higher lease price than paying these costs. Leasing is good for people who do not put a large number of miles on their cars.
How long do you plan to keep the car? If you prefer to get a new car every three to four years, it may make more sense to lease the car rather than buy it. However, if you like to keep your car for longer periods, it is probably a better financial decision to buy a car. Additionally, when you purchase the car, you have an asset after the loan is paid. Over the long-term, purchasing a vehicle and keeping it for a long time will likely be a better financial decision. If you do plan to buy a car, commit to owning it for at least a few years longer than the lease offered.
Can you afford it? You should NOT lease as a means to get a car you realistically cannot afford. You should evaluate your situation beyond the monthly payments to determine if you can afford the car purchase. Understand the difference in maintenance costs associated with owning a car versus leasing it and having these costs covered while under warranty. If you are a business owner, leasing a car allows you to deduct the lease payments as a business expense while buying a car requires you to depreciate it over five years.