Lease or buy a car: What’s the better option?
You’re shopping for a new car. You know which model you want. But how should you pay for it? Financing it with a loan may require a $600 monthly payment, whereas that very same vehicle could be leased for perhaps $350 a month. (Of course, some people will find a way to justify using that $600 a month to lease a fancier car.)
It’s one of those perennial questions, and everyone seems to have an opinion. The big dangling carrot of leasing is clear: cash flow. The problem, of course, is that if you always lease, you will always have a monthly payment.
Let’s break down the difference between a purchase loan and a lease to the fundamentals.
If you buy a car outright and you don’t have the cash to pay for it, you take out a loan. Let’s assume no down payment. If the car sells for $30,000, you’ll need to take out a loan for $30,000, and you may be charged interest for borrowing that money.
With a lease, instead of borrowing the full purchase price of the car, you are only borrowing the amount the car will depreciate over the term of the lease. With a three-year lease, and the expected market value of $15,000 in three years based on regular wear and tear (known as the “residual value”), then you only have to finance the difference between the purchase price and the residual value. Financing $15,000 is going to have a lower monthly payment than financing $30,000, even with a shorter lease term. This is the basic reason lease payments are lower than loan payments.
So with leasing, you have peace of mind. You also have the upgrade factor: Since leases are generally between two and four years, the vehicles are almost always going to be fully covered by warranties and driving them should be problem-free. These are the best years of a car’s life. Once the lease is up, you get to trade in your car for the latest model. You can keep up with the Joneses.
On the other hand, if you took out a five-year loan to purchase the car outright, your monthly payments would stop after five years. It would be only a matter of time before the break-even point was reached.
Of course, you have to consider more than just the difference between monthly payment amounts and length of payments. Over longer periods of time, there will be major maintenance requirements that need to be calculated into the equation. But, for the most part, a person who drives responsibly and pays attention to routine maintenance is going to come out ahead if they buy.
There is no law that says you have to drive a bought car into the ground. If you want to upgrade, you have the option of selling the car any time. After a few years, there should be equity in the car over and above the balance of the loan, which can be used toward a down payment on the next vehicle.
So, as usual, there is a tradeoff: With leasing, you will pay a premium over your lifetime in exchange for a lower monthly payment and very few concerns about reliability. With an outright purchase, you’re going to come out ahead if you can commit to proper maintenance and resist the urge to constantly upgrade.
For those who think solely in terms of monthly payments, a $0 monthly payment at least some of the time is pretty attractive.