Your Next Car–Should You Buy or Lease?
To know what’s best you’ll need to understand the complexities and major differences between buying and leasing cars.
Leasing can certainly make vehicles more affordable in the short term… but does that mean it’s the best decision? Not necessarily. In this episode we’re going to look at the fundamental differences between leasing and buying a vehicle for personal use. Then next week in Part 2 we’ll discuss lots of specific considerations that will help you know what’s right for you.
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What’s Better, to Lease or Buy?
Whether to lease or buy a car is a tricky question with many variables to take into consideration. Leasing has become popular as the cost of new cars has skyrocketed above reach for many buyers. But every buyer’s situation is different, so it’s impossible to give a blanket answer whether leasing or buying is best because monthly payments are just one factor that should influence your decision to lease or buy.
Differences Between Leasing and Buying Cars
So what are the fundamental differences between a lease and purchase loan for a car? A car loan finances the purchase of a vehicle. And a car lease finances the use of a vehicle.
When you purchase a car with a loan, you finance the complete price of the vehicle less any down payment that you make. So if you buy a $40,000 car with a $5,000 down payment, you’ll make up the difference by borrowing $35,000. Your monthly payments are determined by your interest rate and the length of the loan. You can obviously drive the car as much as you like or decide to sell it or trade it for its depreciated resale value at any time before or after you pay off the loan in full.
On the other hand, when you lease a car, you finance just a portion of the vehicle’s price. This is the portion that you will use during the term of the lease. Let’s say you lease a $40,000 car that will be worth $30,000 in 2 years when your 24-month lease expires. This $10,000 in depreciation plus finance charges and fees is the basis for the calculation of your monthly payments. You usually don’t have to make a down payment on a car lease, but may be required to pay a security deposit. At the end of the lease term you can return the car or purchase it at a depreciated resale value.
This is why the monthly payments of a lease can be much lower than the payments of a purchase loan. Loan payments are higher because they include payoff of the principal balance (that was $35,000 in my example) which allow the buyer to build up equity with each payment. The equity in your car is what remains of its original value that you can recoup at resale.
The Sad Reality of Depreciation
For most of us, the reality of buying a car is that we make a decision to invest in something that will decline in value over time with normal use. What a bummer! Unfortunately cars are usually losing propositions; it’s rare to sell one for more than the purchase price or to break even. Cars depreciate the same amount whether the driver owns it or leases it. Simply kiss that depreciated value and say bu-bye! There are certainly exceptions to this for certain models of cars or for professional collectors who really know what they’re doing to make a profit from cars.
But leasing a car is similar to buying in that it’s a losing proposition, but you potentially can lose even more. This is because you don’t have any equity built up in the vehicle to recoup a portion of your depreciation loss at resale. So leasing means no equity with lower payments. And buying equates to having partial equity from making higher payments.
Opportunity Cost of Leasing
So if you think I’m trying to tell you that buying a car is more beneficial than leasing, let me throw you a curve ball. Perhaps you compare the monthly cost of buying versus leasing a car and determine that you’d save $400 a month by leasing. What if you invested that $400 for a nice return on your money? Hmmm, over 24 months, at 6% interest, that could be over $10,000 by the end of the lease.
About the Author
Laura Adams received an MBA from the University of Florida. She’s an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura’s previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.
