Is Leasing a Car a Good Financial Decision?
When you are thinking of purchasing your first car, you might wonder if it makes more sense financially to buy a new or used car, or to lease a car. This is an important decision, but once you understand the terms and conditions involved in both a lease and purchase you can make a comparison to see which makes sense for you. Generally speaking, though, it's better financially to buy a used car rather than buying new, or leasing a car.
A car's value depreciates the most rapidly in its first three years, so at least financially, it's best to purchase a car that is two to three years old. You may be considering leasing because you prefer a new car, or because the monthly payments are lower than the payments on a new car loan. Learning more about how leasing a car works can help you make your decision.
How Does a Car Lease Work?
When you lease a car, the dealer will usually require you to make a down payment on the lease. This payment, called a capital reduction, is like paying a portion of the lease up front. Then you will make monthly payments on the remaining lease balance for the length of the lease.
Usually, these payments are lower than they would be if you were purchasing the car because you're only financing the portion of the car value that you'll be using over the (typical) three-year life of the lease. The lease will have requirements that you need to meet to avoid any additional charges at the end of the lease term.
One of these is a mileage limitation. Your lease will specify the number of miles that you can put on the car during the lease, often stated in terms of annual miles, such as 10,000 or 12,000 miles per year, without having to pay a per-mile charge for going over your lease limit. In some cases, you can buy additional miles upfront or negotiate a per-mile rate to pay at lease-end if you go over your mileage quota.
If you go over your lease mileage, you will be assessed a certain charge per mile over the lease limit. You may also be assessed additional charges for any bumps or dings to the car or worn-out tires unless you pay to replace tires and get any damage repaired before turning the car in.
It's important that you keep up regularly-scheduled maintenance on the car. At the end of the lease, you will have the option to purchase the car for its residual value by buying out the lease, or you can turn the car in.
- Check the terms of the lease including buy-back options and mileage
- Get everything in writing including maintenance requirements
Some car manufacturers include all regularly-scheduled maintenance at no additional cost for the life of the car lease. Check with the dealer for your desired leased car model to see if they offer such a deal.
There is much to consider in the lease vs. buy discussion, but much of it can be boiled down to a few key leasing benefits and disadvantages that you can use to guide your decision making:
Leasing has lower monthly payments
You can get a new car model every few years
You don't need to perform any major car repairs
You'll always have a car payment if you continue to lease
You won't have anything to show for your money at end of lease
The dealer may assess additional fees, such as mileage overage charges
The Benefits of Leasing a Car
A car lease usually offers lower monthly payments than if you were buying the car. If you feel like you always need a new car, this is a way to get into a new model every few years. You typically only need to deal with maintenance in the first three years of owning a car, without having any major car repairs due to age or wear and tear.
While you may end up with a lower monthly payment, over the years, you will never be without a monthly car payment if you continue to lease. Additionally, you will need to have a down payment for your lease every few years, and you won't have any trade-in value if you're getting out of one lease and into another. If you want to lease your cars continually, plan to come up with a down payment every three years, which could require you to save money each month in addition to your monthly lease payment.
What Are the Disadvantages of a Car Lease?
Leasing a car presents many financial issues. For example, at the end of the lease, you have nothing to show for all the money you've spent. You must either turn the car into the dealer (where they may try to convince you to trade up to a new lease), or you must purchase the car at the end of the lease.
There are also unexpected fees associated with leasing a car. Unless you're constantly vigilant, the mileage limits are often difficult to stay under, and you could find yourself paying hundreds in over-mileage charges at the end of your lease.
Although a car is not an investment because it never appreciates in value, purchasing gives you the option to pay the car off and drive it for a few more years while not having a car payment. You can also sell the car and get some money for it to put towards your next car when you are ready to move on.
Few dealers will let you break your lease without penalty. You may be able to transfer the lease, or buy out the car early and try to sell it to recoup costs.
How Can I Save Money on a Car?
The way to save the most money on a car is to purchase with cash. If you finance a car, you need to be able to afford the monthly payments that you choose, and you'll pay interest on the money that you're borrowing.
Imagine what you could do with your money if you didn't have car payments to worry about because you saved up and paid cash. You will save the most money by buying a reliable used car that's a few years old, and by taking proper care of the car.
When you purchase a used car, take it to a mechanic you trust and have it inspected so that you know the car you're buying is in good condition.
Take time to research the model and year of the car you want and check the car's title status, especially if you are buying from a private seller.
If you can't pay with cash make sure you don't take out car payments you can't afford. You can get prequalified, or even take out a used car loan and approach the seller with a check from your financing company. The benefit here is that you'll likely get a lower rate than you would get at a dealer, and you can buy from a private party as if you were writing a regular check.
If you're unable to buy outright, it's generally best if you're able to pay off the car within three years, which keeps the amount you pay for interest to a minimum. As a benchmark, your total monthly debt, which would include your car payment if you finance it, should be less than 25 percent of your current gross income. If you stick within these parameters, you will keep yourself in a much better situation financially. The lower your overall debt-to-income ratio, the more likely you are to be approved for a mortgage and other loans.
If you are having trouble qualifying for a car loan, you may have to buy with cash, which can limit your purchasing power. You must meet the same credit qualifications to lease or buy. If you're financially strapped for a bit, consider investigating and joining a car share for transportation while you save up cash to purchase your car.