Besides your house, your car is probably the most expensive item you have, at least until you save up enough for that private jet. Consequently, choosing which car to drive and how to finance it is an incredibly huge decision. It’s one that impacts how much you’re able to spend in other areas of your life and how frequently you go to the mechanic for repairs.
Most people can’t afford to buy a car with cash anymore, particularly for a newer model. If that’s you, you’ll need to determine whether you’ll buy your vehicle with a loan or lease it for a few years.
The choice isn’t as straightforward as you might think; in fact, the best decision for you depends on a lot of different variables, including what kind of car you want, how long you plan to keep it, and how your current cash flow looks. Brush up on the basics so that you can plan on the most informed decision the next time you get ready to purchase or lease a new car.
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Buying a Vehicle with Financing
When you finance your vehicle, you borrow the amount of money you need to purchase the car (minus any down payment you make) and then repay the loan — along with interest — each month for a set number of years. The average length of a car loan is now up to 5.5 years, so it’s important to find the best loan to keep your monthly payment as low as possible for that length of time.
There are a couple of different ways you can buy a car with a loan. The first is to seek out a lender on your own, whether it’s a bank or credit union. The benefit of choosing this option is that you can shop around for the best offers before heading to the dealership. You’ll know exactly what loan amount you qualify for and how that amount translates into monthly payments.
Your other option is to get dealership financing, where you actually take out a loan through the car dealer rather than directly through a financial institution. Dealerships typically have access to multiple financial institutions so they can give you several financing options. There’s also the added convenience of being able to shop for a car and loan at the same time, especially outside of typical business hours. There may be an added finance charge for using dealer financing, so it’s wise to compare all offers before choosing one.
Leasing a Vehicle
When you lease a vehicle, you essentially rent it for a certain period of time. You’ll make a small down payment, followed by monthly interest payments. None of your payments goes towards principal because you have no ownership of the car. Once your lease ends, you simply return the car to the leasing company. Additional fees might include mileage charges if you surpass your limit and wear-and-tear fees if the car is left in less-than-prime condition.
One of the upsides of leasing is that you can upgrade to a newer model without worrying about having to sell your old car. The downside is that you don’t have a car to use for trade-in value when buying a new vehicle. In the short-term, leasing a car is often less expensive, but over time, it can become more expensive than buying a car.
Comparing Car Purchase vs. Lease
Now that you understand the basic mechanics of purchasing a car versus leasing one, let’s compare the pros and cons of each one so you can get a better idea of which might work for you.
Leasing: Pros and Cons
One of the most attractive things about leasing a vehicle is that you can often afford a much nicer car for less money than if you were to buy it outright. The required down payment is much less, and you might even be able to find a deal requiring no down payment at all. Compare that to the usual 20% down payment when purchasing a vehicle, and you can save some serious money upfront.
You’ll also avoid paying as much in sales taxes. Your monthly payments usually end up being lower because you’re not paying on the full amount of the car’s value — just the depreciation. And you typically receive a factory warranty along with the car, which helps with any repair costs that may pop up during the lease. After a few years when your lease is up, you can avoid trade-in negotiations and simply lease a new car again.
With all those benefits, why wouldn’t you lease a car? Well, a lease can come with a few negatives. First of all, you need relatively good credit in order to qualify for a vehicle lease. And even though you make payments on the car over the lease period, you don’t actually own anything when it’s finished (although you do have the option to purchase the car afterward).
Over time, continually leasing cars becomes less economical because you’re constantly re-upping contracts with fees and down payments. Not only that, driving a leased car comes with a complex lease agreement, so you need to make sure you fully understand the fine print. One constraint is the mileage limit, usually capped at 12,000 miles a year.
You can purchase more miles if you need to, but again, that adds to your overall cost. You can also be charged wear-and-tear fees at the end of your lease term and can also be charged if you need to end your lease early.
Buying: Pros and Cons
There’s no doubt that buying your car outright likely saves you money over time. When it comes time to sell, you have more flexibility because you can negotiate your trade-in value and put that towards the purchase of a newer car. You also gain flexibility in your use of the car.
Since you own it, you can modify it however you want. Not only that, you don’t have to worry about mileage or wear and tear penalties. It’s just like owning a home versus renting one: you don’t have to ask your landlord permission to paint the walls, or worry about losing your security deposit because of any damage done.
On the flip side, there are some disadvantages that come with buying a car. You’ll have to put down a higher down payment, so it can be difficult to do if you don’t have cash available. If you’re buying the car new with a loan, its value decreases quickly so you may end up owing more on the loan than your car is worth. That’s a huge consideration to take into account. Your monthly payments will also be higher compared to the lease, plus you’ll be solely responsible for repair costs once your warranty ends.
Next, let’s take a look at the upfront costs associated with both buying and leasing. With both options, you’ll have to pay taxes, registration, and other fees that might come along with financing the loan or lease. When buying, you can tack onto that the cost of your down payment. When leasing, your down payment might be lower, but you’ll also have to pay the first month’s payment and security deposit. Make sure you understand all of the fees for each option before you make a decision.
Which is right for you?
So which should you do: buy or lease your next car? It’s a very personal decision, but here are a few ways to get you pointed in the right direction. First, consider your credit. What kind of rates will you qualify for in both scenarios? It’s definitely ok to price check both options before choosing one. Next, consider your current cash reserves. What kind of down payment can you afford? A lease might cost a less upfront.
Finally, consider your long-term vehicle plans. Do you need a quick, reliable ride while saving up for a more long-term solution? Or are you ready to invest in something that will last for years, and later go towards a trade-in? You should also consider your driving behavior. If you drive for a living, you might feel inhibited by the mileage restrictions of a car lease. Similarly, if you don’t take particular care of your car, you might get hit with some hefty fines. In those cases, buying might be the best choice for you.
Don’t feel rushed in making the decision between buying and purchasing. Even if you need a car as soon as possible, both options stick with you for at least a few years, if not more. Give yourself the time to evaluate each type of financing you qualify for.
It’s ok to simply call lenders and leasing companies to ask for estimates based on your personal information. After all, you’re likely going to spend thousands, if not tens of thousands of dollars on this vehicle no matter how you pay for it. Do yourself a favor and perform adequate due diligence to make sure you’re not wasting money.