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April 1, 2014

 

 

 

 

 

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Lease vs Buy a Car

Which is better: Leasing or Buying?

It's a common question for anyone considering leasing: lease versus buy — which is better?

So what is the answer?

Lease versus Buy

The answer is – it depends. It's not possible to simply say that one is always better than the other because the answer depends on the specifics of each individual situation.

Leases and purchase loans are simply two different methods of automobile financing. Car leasing is not renting as many people seem to think. It's not at all like apartment leasing.

Leasing is a way of financing the use of a vehicle; buying with a loan finances the purchase of a vehicle. Each has its own benefits and drawbacks.

When making a 'lease or buy' decision you must look not only at financial comparisons but also at your own personal priorities —based on what's important to you.

Ask Yourself Some Questions

Is having a new vehicle every two or three years with no major repair risks more important than long-term cost? Or are long term cost savings more important than lower monthly payments? Is building some ownership value in your vehicle more important than low up-front costs and little or no down payment?

Is it important to you to pay off your vehicle and be debt-free for a while, even if it means higher monthly payments for the first few years? Or is it more important to update your vehicle every few years to get the latest styling, new technology, and best safety equipment?

So we find out that making a lease-or-buy decision is not quite cut-and-dry. There are trade-offs, pluses and minuses, pros and cons to consider.

Buying and Leasing are Different

When you buy, you pay for the entire cost of a vehicle, regardless of how many miles you drive it or how long you keep it. Monthly payments are higher than for leasing. You typically make a down payment, pay full sales taxes in cash or roll them into your loan, and pay an interest rate determined by your loan company based on your credit score. You make your first payment a month after you sign your contract. Later, you may decide to sell or trade the vehicle for its depreciated resale or trade value, which may be considerably less than the vehicle's original cost

When you lease, you pay only a portion of a vehicle's cost, which is the part that you "use up" during the time you're driving it. Leasing is a form of financing and is not the same as renting. You have a choice of not making a down payment, you pay sales tax only on your monthly payments (in most states), and you pay a financial rate, called money factor, that is similar to the interest on a loan. You may also be required to pay fees and possibly a security deposit that you don't pay when you buy. You make your first payment at the time you sign your contract — for the month ahead. At lease-end, you may either return the vehicle, or purchase it for its depreciated resale value. You may be charged a lease-end disposition fee, and for any excessive mileage or wear-and-tear.

buy lease car

Lease-vs-Buy Example

As an example, if you LEASE a $20,000 car that will have, say, an estimated resale value of $13,000 after 24 months, you only pay for the $7000 difference (the depreciation), plus finance charges. You return the car at lease-end, or buy it for the remaining $13,000 that you haven't already paid.

When you BUY with a loan, you pay the entire $20,000, plus finance charges. You own the car at the end of your loan, although its value is less than the $20,000 you initially paid — $7000 less. All cars suffer the same value depreciation regardless of whether they are purchased or leased. You have the option to sell or trade the vehicle, or continue to drive it while you enjoy having no monthly payments.

This difference — financing $7000 versus $20,000 — is fundamentally why leasing offers significantly lower monthly payments than buying.

How are Car Lease and Loan Payments Different?

Lease payments are made up of two parts: a depreciation charge and a finance charge. The depreciation part of each monthly payment compensates the leasing company for the portion of the vehicle's value that is lost during your lease ($7000 in our example above). The finance part is interest on the money the lease company has tied up in the car while you're driving it. In effect, you are borrowing the money that the lease company used to buy the car from the dealer. You repay part of that money in monthly payments, and repay the remainder when you either buy or return the vehicle at lease-end.

Loan payments also have two parts: a principal charge and a finance charge, similar to lease payments. A loan company or bank issues money directly to you or a dealer, and you agree to repay that money, with interest, over time. The principal charge pays off the full vehicle purchase price ($20,000 in our example above) over the length of the loan, while finance charge is loan interest on the monthly unpaid balance. The finance company or bank will hold the vehicle's legal title of ownership until the loan has been completely repaid.

However, since all vehicles depreciate in value by the same amount regardless of whether they are leased or purchased, part of the principal portion of each loan payment can be considered as a depreciation charge, just like with leasing — it's part of each monthly payment that you never get back, even if you sell the vehicle in the future. It's lost money for which you'll have nothing to show, just like with leasing.

The other part of each loan principal payment, after depreciation, goes toward equity value. Equity is what remains of your car's original value at the end of the loan after depreciation has taken its toll. Equity is resale or trade value. It's what you get back if you sell the vehicle — or credit you receive if you trade. The longer you own and drive a vehicle, the less equity value you have. At some point in time, after the wheels have fallen off and the engine is worn out, the only equity left is scrap value. You never get back the full amount you've paid for your vehicle.

Buy versus Lease - Savings Account or No Savings Account

So, buying a car with a loan is essentially like putting money into a declining-value savings account — you never get out as much as you put in. A portion of every payment you make is lost to depreciation and finance charges. What you have "to show" for your investment when your loan is paid off is only the part that is left over after depreciation and interest. However, if you plan to drive the vehicle for many years to come, its equity value is of little concern to you.

Leasing, then, is similar to buying, but without the equity "savings account." You only pay for what you use (the depreciation) and you don't put anything extra each month into "savings." It's true that you'll own nothing at the end of a lease; you'll have nothing "to show" for the money you've put into it. But... what you don't own is the same part of the car's original value — the depreciated part — that a buyer too doesn't own at the end of his loan. Again, a car's value depreciates the same amount whether it is leased or purchased. That money is gone forever, lease or buy.

With leasing, you may have the option of putting your monthly payment savings into more productive investments, such as mutual funds or stocks that have the possibility of increasing in value. In fact, many experts encourage this practice as one of the benefits of leasing, though most people will typically find other uses for the money they save by leasing — such as paying the mortgage or buying groceries.

Leasing Can be a Little More Complicated

Because leasing is made somewhat more complicated with residuals, term, money factors, acquisition fees, etc.; it shouldn't be undertaken quite as casually as you might with a car loan. There are more opportunities to misunderstand and make mistakes. Therefore, leasing requires that you be more careful and more informed. This is precisely the reason we've provided this Lease Guide and our optional Lease Kit — to make leasing as easy and understandable as possible.

Leasing may also require a higher credit score than a car loan. There are actually 3 credit bureaus that report your credit. You can see all 3 bureau reports and 3 scores with a $1 seven-day trial instantly online with a simple enrollment in CreditReport.com. Your score might mean the difference between leasing and buying, or not getting approved for either.

Leases are More Difficult to Evaluate

lease deal calculatorIt's easy enough to evaluate a car purchase based simply on price. You can use a free service such as TrueCar to compare the price you are being offered to what other people are paying for the same car.

However, evaluating a lease is more difficult because payments are based on a combination of factors, of which price is only one. There's also residual value, term, and money factor. To help you, we've developed an easy-to-use free online Lease Deal Calculator that does the job for you.

Just a Comment on Lease-to-Buy Plans

Some people lease with the intention of buying their vehicle at the end of the lease, or before the end of the lease. It allows them to start out with lower payments by leasing and then buy the car at lease-end with a used-car loan. This technique is nearly always more expensive in the long run than simply buying outright. However, you may have a good reason for this tactic — such as keeping your monthly payment within budget — and don't mind the extra long-term cost.

One Other Thing - GAP Protection

Most car leases have automatic built-in GAP coverage, while car purchase loans do not. GAP coverage, or GAP insurance, pays the difference between what you owe on your loan or lease, and what your vehicle is actually worth if your vehicle is stolen or destroyed in an accident.

Why is GAP insurance important? Because it's very common, in these days of long-term loans and leases, rolled-over and refinanced loans, and little or no down payment, to be "upside down" — to owe more on your loan or lease than your car is actually worth.

This can mean you'll still owe hundreds or thousands of dollars to the finance company even after your insurance has paid for your car that has been totaled or stolen. This turns out to be a huge shocking surprise for most people caught in this unfortunate situation.

So, nearly all leases have built-in GAP protection, but loans do not. You're better protected with a lease, unless you purchase the insurance separately at extra cost for the loan — if you can find a place to buy it.

Which is Better - Buying or Leasing ?

As with any question of this type, there can be more than one answer, depending on particulars.

Lease vs Loan

Typical lease compared to a 6% loan and a 0% loan. Leasing always has lower payments. Does this mean leasing is always better? Not necessarily. Payment is not the only factor that should influence your decision.

  Lease- 6% Loan - 0% Loan - 6%
Car Price $23000 $23000 $23000
Down Payment $1000 $1000 $1000
Interest Rate 6% 0% 6%
Residual $11000 n/a n/a
Months 36 36 36
Payment $388.06 $611.11 $669.28

Let's simplify the answers and summarize them here:

1. The SHORT-TERM monthly cost of leasing is ALWAYS SIGNIFICANTLY LESS than the cost of buying.
For the same car, same price, same term, and same down payment, monthly lease payments will always be 30%-60% lower than loan payments. This is still true even when compared to 0% or low-interest loans (see comparison chart at right). For actual real-life comparisons, see our Lease vs. Buy Calculator.

2. The MEDIUM-TERM cost of leasing is ABOUT THE SAME as the cost of buying, assuming the buyer sells/trades his vehicle at loan-end and the leaser returns her vehicle at lease-end.
The overall cost of leasing compared to buying, over the same lease/loan term, is approximately the same, assuming the buyer sells or trades the vehicle at the end of the loan. Comparisons sometimes show buying to cost a little less than leasing due to fewer fees, lower total finance costs, and the assumption that a purchased vehicle will return full market value if it is sold or traded at the end of the loan (often a bad assumption, especially if traded). However, when the benefits of wisely investing monthly lease savings are considered, along with sales tax savings (in most states), the net cost of leasing can easily be less than buying. For more details see our article, Lease vs Buy - The Real Math.

3. The LONG-TERM cost of leasing is ALWAYS MORE than the cost of buying, assuming the buyer keeps his vehicle after loan-end.
If a buyer keeps his car after the loan has been paid off and drives it for many more years, the cost is spread over a longer term. It doesn't take rocket science to figure out that the cost of buying one car and driving it for ten years is less expensive than leasing or buying four or five different cars over the same period. Therefore, leasing is always more expensive than long-term buying. If long-term financial cost savings were the most important objective in acquiring a new car, it would always be best to buy the car and drive it for as long as it survives — or until the cost of maintenance and repairs begins to exceed the cost of replacing it. However, many automotive consumers have other more immediate objectives that are more important than long-term cost savings.

Lease or Buy? What's Important to You? What Are Your Priorities?

It's personal. All of us have different personal styles, objectives, and priorities — in cars, life, and in finances. Car lease-versus-buy decisions must be made with your own lifestyle and priorities in mind. What's right for one person can be totally wrong for another.

LEASE - If you enjoy driving a new car every two or three years, want lower monthly payments, like having a car that has the latest safety features and is always under warranty, don't like trading or selling used cars, don't care about building ownership equity, have a stable predictable lifestyle, drive an average number of miles, properly maintain your cars, are willing to pay more over the long haul to get these benefits, and understand how leasing works, then you should LEASE.

BUY - If you don't mind higher monthly payments at first, like owning your your cars for more than 2-3 years, prefer to build up some trade-in or resale value (equity), enjoy the idea of having ownership of your car, like paying off your loan and being payment-free for a while, don't mind the unexpected cost of repairs after warranty has expired, drive more than average miles, prefer to drive your cars for years to spread out the cost, like to customize your cars, or you might have lifestyle or job changes in the near future — then you should BUY.

Another Way to Lease — A Better Cheaper Leasing Alternative

The single best way to drive a late model car at the lowest possible cost is to take over someone's existing car lease. It's less expensive than buying and less expensive than taking out a new lease. You avoid all the up-front hassles, negotiations, and fees.

Why?

Most existing car leases were taken out months ago when car manufacturers were offering incredible money-losing lease deals and very low monthly payments. Many people who took those great lease deals now need to get out after losing a job or suffering other financial distress. Most lease companies allow those leases to be transferred to someone else by simply paying a small transfer fee.

Since the original lessee got a good deal — a deal that may not be possible today — anyone taking over the lease will inherit the same great deal, same low monthly payment, with no money down, no up-front sales tax, and in many cases, a cash incentive from the "seller." There is no other way to get a late model car this cheap with payments this low.

Online companies such as Swapalease.com act as match-makers between people who want out of a lease, and people who would like to take over a lease. This company is the largest online lease marketplace and has the largest inventory of lease takeover vehicles. You can look over their vehicle listings and if you find a car you like, they help arrange the lease transfer. The "seller" pays most of the cost. It's easy and fast.

Summary

To summarize, car leasing is the right answer for people who want to save on monthly automobile costs but who have a stable predictable lifestyle and take good care of their cars. Buying is better for those who drive lots of miles, who like paying off their auto loan and enjoying their car without monthly payments for years to come.

Remember, whether you lease or buy, or take over an existing loan, your current credit score can make the difference between a good deal or bad deal, or no deal at all. Always know your credit score, which you can always see instantly with a simple enrollment in online services such as CreditReport.com. Don't be surprised by what a dealer knows about you that you don't know about yourself.