Is it Better to Lease, Finance, or Outright Buy My Next Car?
Whether you’re driving the kids to school, trekking to and from work or getting away for the weekend, your car is an indispensable part of your day-to-day life. But if it’s on its last legs (or if you’re thinking about buying a car for the first time for yourself or someone in your family) you may be wondering about the best way to pay for it.
Here are your three choices:
- Leasing means you don’t actually own the vehicle – you make a monthly payment, get to enjoy it for a set period of time, then return it and walk away at the end of the lease period.
- Financing, like a mortgage for your home, involves making monthly loan payments – and when the loan is completely paid off, presto – you own your car.
- Owning outright means you pay the entire price of the vehicle upfront with no monthly leasing or financing payments.
Now, let’s dig a little deeper and explore the differences and pros and cons between these options.
Leasing: Lower upfront costs may come at a price later on
If you’ve rented a vehicle for the day or a weekend, you know the drill: you pay a set charge and – unless you go over the mileage limit or ding the fender – when you’re done you simply hand back the keys. Leasing is essentially like renting but for a longer period of time. You get to enjoy the car while it’s in your possession but once the fixed-term lease agreement runs out, you simply bring it back and walk away (or you may have the opportunity to buy it outright with cash or financing).
The main benefit to leasing is there are few upfront costs – usually just a first month’s payment, a refundable security deposit and some other fees – and monthly lease payments are almost always lower than financing payments, which we’ll talk about below. That’s because, with a lease, you’re only paying for a vehicle’s depreciation during the lease – usually 2 to 4 years.
There are still a few catches, however. The biggest may be on mileage – a lease agreement usually includes a strict kilometer limit and if you exceed it by the end of your lease, you’ll have to pay some potentially hefty penalties. Also, if you don’t take care of the vehicle and wear and tear is beyond what’s considered normal, there could be additional charges.
Finally, sometimes plans change and you may find yourself wanting to end the lease early. If you do, you’ll need to pay the outstanding payments on the lease or an early termination fee. (There are ways around this: you can try to transfer the lease to a family member or friend, or buy the car outright and then try to sell it – but the process can be a hassle.)
Spotlight: Gap Insurance?
Did you know, when you lease a vehicle from a dealership, you may be offered gap insurance (also called gap protection) is mandatory, which protects you if your vehicle is totaled or stolen?. This type of insurance, which usually runs from $350 to $8001, basically covers the “gap" between what your vehicle is worth and how much you owe on your lease. If the car you’re leasing is less than three years old and/or you’re getting a pricier luxury model, gap insurance may be worth your while.
Financing: Higher payments now but more flexibility down the road
If you’ve ever had a mortgage, you know how auto financing works – you enter into a contract with a bank or other lender and make loan payments to pay down the principal and interest.
Just like leasing, however, there are some potential pros and cons. One of the biggest benefits to financing is that, once the loan is paid off, you own the car. And, if you choose to sell it, you can recover the remaining equity in your vehicle to use as a down payment for a new one, to pay down other loans, like credit cards, or to splurge on whatever you like. Also, on the plus side:
- Vehicle financing can help you rebuild your credit score – as long as you make your monthly payments in full and on time.
- If you don’t want your car anymore, you can sell or trade it in anytime, without end-of-lease charges.
- There are no mileage limits like in a leasing contract, so you can drive to your heart’s content – although, keep in mind, a higher number on the odometer could lower your vehicle’s resale value in the future.
On the downside, monthly financing payments are usually higher than for a lease because they’re based on the car’s entire purchase price (as opposed to leasing, where payments are based on the time you’re in possession of the vehicle), plus interest and other charges.
Buying outright: You’ve got cash on hand but should you use it?
Most of us don’t have the full price of a new car sitting in our bank account, but if you’re lucky enough to be in that position, paying cash for your car is worth considering.
After all, if you’re not leasing or financing, you don’t have to pay interest, right? While this does sound like common sense, the fact is many leases and loans have very low interest rates, which means you’re not actually likely to spend much on interest. On the other hand, cash incentives from the dealership may make paying cash even more attractive. It’s also worth considering that, if you keep your cash available for other projects or investments, it may actually earn you a higher return than the interest you’d pay for your car’s lease or financing.
The bottom line? If you believe you can earn more on your savings or investments than the cost of borrowing for a lease or loan, take a serious look at paying cash. Otherwise, leasing or financing may be the way to go. Ultimately, the best option for you will depend on your own individual circumstances.
Looking at a car and want to know what the cost of your insurance could be?