Comparing the two major finance choices. Buying vs leasing a car
Deciding how to pay for your next vehicle can be one of the most stressful parts of the purchase decision. You could pay cash, finance, or lease the vehicle and with each option, there are even more decisions that have to be made. Thankfully, the decision on whether to buy or lease is fairly straightforward. In this article, we will walk through a brief overview of both types of purchases, look at the pros and cons of each, and then I’ll make a recommendation based on your unique situation.
If you’ve had a particularly good experience with either financing or leasing a car, please leave a comment below. We can all learn from each other and demystify this often confusing topic.
I will make a few assumptions in this article. They are: that you’ve already located the right car for you, the right dealership for you, and you’ve negotiated to the lowest possible purchase price. If you haven’t, there are great resources available on this site to help you with those steps in the purchase process also.
Explanation of Financing
When most people think about purchasing a new vehicle, they are thinking of financing their new vehicle. This is a valid answer to the question of “how to pay for your next vehicle?” However, I still wanted to take the time to explain how this process worked and how your monthly payment is determined.
When you decide to finance a vehicle, the dealership applies for financing on your behalf. Then you sign a contract in the F&I office and off you go in your new vehicle. Then, about 30 days later, a bill shows up in the mail and you’ll make your first payment.
The main factors that go into your monthly payment are the purchase price of the vehicle, the interest rate, and the term of the loan. Remember, with financing a vehicle, you are taking the total purchase price and dividing it by the number of payments and then factoring in the interest rate. Be sure to negotiate on all fronts to avoid paying too much in the finance office.
When you finance a vehicle, the vehicle is yours. You can drive it as many miles as you wish, customize it to your liking, and know that eventually your vehicle will be paid for, and it will be yours to keep.
Explanation of Leasing
Leasing is a great option for certain people when deciding how should I pay for my next car. Leasing has some great benefits and you are sometimes able to drive a much nicer car for a smaller monthly payment. It can also be thought of as a long-term rental on a vehicle, with the option to purchase it at the end.
Leasing has to be done through the dealership that you are buying your vehicle from. Also, it commonly is only an option on new vehicles. The dealership will use the bank or manufacturer programs to determine how much your payment will be. You will sign a contract in the F&I office, drive off in your new car, and receive a bill later that month. You’ll make payments for a set amount of time, drive a set amount of miles, and then return your vehicle and do it all over again.
The key things to watch out for when negotiating a lease are the purchase price of the vehicle, the residual value (what percentage of the vehicle is “left over” after the lease), and the money factor(basically, the interest rate of the lease). Please do whatever you can to negotiate all of these aspects aggressively.
When you decide to lease a vehicle, you are essentially doing a long term rental of the vehicle from the lender. You can drive the vehicle for a predetermined amount of miles and for a set time period. At the end of that period you have to turn in the vehicle or buy the vehicle at a pre-set price. Then you start the process over again.
Pros of Financing
There are many pros to financing a vehicle, rather than leasing it. I’ve taken some of the top reasons to finance and listed them here. They are:
A good-ish investment
No, I’m not saying that your car will go up in value. What I am saying is that after your vehicle is paid off, you can simply keep driving it and not have to make a car payment for many years. It is not uncommon to see a 10-12 year old acr with no major mechanical problems. If you had purchased this vehicle new and financed it for 6 years, you could have 4-6 years worth of car payments relaxing in your bank account.
You’re free to drive as much as you want
With a lease, you have a pre-set amount of miles that you can drive and are charged extra for every mile that you exceed that limit. With financing a vehicle, you can literally drive as much as you desire. This freedom and flexibility is good no matter how much you drive. If you don’t drive much and you finance your vehicle, you don’t have to pay for miles that you aren’t going to use like in a lease. If you drive many miles each year, you don’t have to pay a lot of money for mileage overages.
You can customize your vehicle
Do you want to change the wheels & tires of your new vehicle or maybe install an aftermarket stereo? If you answered yes to either of these items, you shouldn’t lease a vehicle. Making customizations to a leased vehicle is a great way to get hit with a large number of fees and penalties. Lenders intend for the leased vehicle to be returned in the same condition that it was purchased in, and making customizations is not part of their plan.
Pros of Leasing
Leasing is quite attractive for many people, and for good reason. Read on to see some of the biggest benefits to leasing your next vehicle:
Can be much cheaper than financing
When you finance a vehicle, you are paying for the total cost divided up into equal payments. However, when you lease, you are only paying for a portion of the vehicle’s total value, so your payment will tend to be much lower. A good rule of thumb to remember when leasing is that your all-in payment, with tax included, should be around 1% of the vehicle’s MSRP per month. If you can do this, you are getting a great deal!
You can always have the latest and greatest
One of the main advantages to leasing is that you have the opportunity to get a new car every few years. This means that you can have the latest technology, performance upgrades, and advanced safety features. You do not have to try to retrofit your old vehicle with this new tech. Instead, you can just lease a new model and have the newest technology.
Your vehicle is covered under warranty
With most manufacturers offering a 3 year or 36,000 mile warranty, there is a good chance that your leased vehicle will always be covered by the bumper to bumper warranty. This means that you won’t have to worry about anything other than recommended maintenance like oil changes. If any large item breaks in your vehicle while it is leased, it is the responsibility of the manufacturer to fix it, not you!
You’ll never owe more than the vehicle is worth
In other words, it’s impossible to be “underwater” on a lease because the ending value of the lease is fixed from the beginning. This means that you don’t have to worry about negative equity or coming up with cash down to get out of a vehicle. Rather, you can simply return the vehicle at the end of the lease to a dealership and walk away. Pretty sweet, right?
Cons of Financing
Just like anything else, there are a number of cons to financing your vehicle. Although financing may still be the best option for you to take, these are good items to keep in mind. They are:
Ahh, depreciation. The cruel enemy of new cars everywhere. I’m sure you’ve heard the old adge by now that a vehicle drops 30% in value as soon as you drive it off the lot. This means that you can be in a position where you owe more than your vehicle is worth. This doesn’t matter in theory if you plan to keep the vehicle for a long period of time, but can be problematic if you trade often.
Higher monthly payments
When you lease a vehicle, you are only paying a portion of the vehicle’s value. When you finance, you have to pay the full amount of the vehicle over several years. This often leads to your monthly payment being significantly more than if you had leased the same vehicle
Threat of Maintenance Items
The most common finance term is 72 months and most warranties are only for 36 months. This means that you will be driving your vehicle without a bumper to bumper warranty while still making payments. This can prove problematic if you are forced to make a costly repair to your vehicle and still have to make your high monthly payment.
Cons of Leasing
As we discussed earlier, leasing is a great idea in specific situations. However, it isn’t for everyone. Here are some reasons why you might not want to lease your next vehicle. They are:
Empty handed at the end of the Lease
A lease, by definition, is a long term rental of a vehicle for a set period of time with a set number of allowable miles. This means that you must return the car to the manufacturer after 34, 36, or 39 months and you’ll be left empty handed. You’ll also have nothing to show for all of the payments that you made.
Very Rigid Structure
If you are in the middle of a lease and suddenly need to drive an extra 500 miles a week for a new job, you are going to have serious issues. Also, do you have a great opportunity to move out of the country for a promotion? It is going to be hard to do with leased vehicles. Leases are not very flexible in terms of changes to life. Unless you are able to find someone to assume payments for you, you will be stuck making the number of payments stated in the lease contract.
There are significant advantages to each type of vehicle ownership. My advice to you if to think through your purchase options, find a dealership that you enjoy, and negotiate hard on the purchase price of the vehicle.
If you can answer yes to the following questions, leasing might be the best option for you:
- Do you have a steady job and stable life?
- Is the number of miles that you travel per year consistent?
- Do you like to have the latest and greatest technology in your vehicle?
- Does paying for out of warranty repairs stress you out?
Financing a vehicle might be the best answer if you can answer yes to these questions:
- Do you plan to buy a vehicle and drive it until the wheels fall off?
- Do you want to be able to customize your vehicle?
- Are you comfortable with paying for out of warranty repairs?
- Does the number of miles that you travel per year vary widely?
Did you decide to finance or lease your vehicle? Leave a comment below to share what made you decide the option you picked.
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