When it’s time to buy a car, you have a few choices. You can buy a new car, purchase a used one or lease a car for a reasonable monthly fee. There are pros and cons of buying and leasing, but for many, buying a car will be the best financial route.
Buying a Car
If you have the cash on hand, one of the best things you can do is pay cash for a car. This often makes the best financial sense, especially if you’re okay with a used car. Once you’ve bought your first car, you can use it as a trade-in and get a deal on a replacement vehicle when you’re ready.
Many consumers don’t have the money to purchase a vehicle in full, though. The alternative is to take out a loan that you repay in monthly payments, with interest. The average monthly car payment is $554 for a new car and $391 for a used car, according to Experian.
Leasing a Car
A popular alternative to buying a car is leasing one. Like a long-term car rental, leasing lets you drive a car for a specific period, turning it in at the end of the term. The leasing company sets the terms and you pay a down payment plus monthly payments until you return the car.
One reason many consumers opt for leasing is that the monthly payments are low, especially since you’re usually getting a new car. Typically, you can lease a better car for less than you’d pay on a monthly car payment. The average lease payment, according to Experian, is $467 per month, which is significantly less than you’d pay for a new car.
Read More: Pros and Cons of Leasing a Car
Ownership Value vs. Lease Credit
The biggest benefit of buying a car is that once the loan is paid off, it’s yours. Even if you don’t pay it off, when you’re ready to get a new one, your old car may have more value than your remaining car payments. This gives you a little extra money to use as a down payment on your next car.
But one of the best things about a lease is that you can trade it in on a new car at the end of the lease term. Some leasing companies have something called a pull-ahead offer, which gives you a credit toward a new lease. You also have the option to buy the car for a fee specified in the lease you signed. Often this cost is more than you’d pay if you bought the car through a dealership or car lot, though.
Maintenance on a New vs. Leased Car
Before signing a lease, check the warranty to see what’s covered. If you're leasing a new car, major issues are typically covered for a limited time, but this is also the case if you buy a new car. You can also purchase an extended warranty that covers other maintenance issues, but this is also the case whether you’re buying or leasing.
With a leased car, though, you’ll be subject to a lease inspection when you turn your car in. Normal wear is allowed, of course, but what the leasing company defines as “normal wear” can make things tricky. Under a leasing contract, you could end up owing money for damages like dents and scratches at the end of the lease.
Mileage Restrictions on Leased Vehicles
Your lease comes with a mileage limit, which makes it a better deal for infrequent drivers. If you're getting close to the number of miles you're allowed each year, you may find yourself renting a car when you go on a trip simply to avoid exceeding your mileage allotment. You can negotiate this as part of your lease, but it can vary from 12,000 miles a year to 100,000 miles or more.
But the number of miles isn’t just a liability with leases. If you buy a car, depreciation comes into play. A car typically drops $5,000-$10,000 in value during the first 3,000 miles you drive. After that, depreciation slows down, but experts figure you lose about $0.25 to $0.50 per mile after that first 3,000 miles.
The New Car Lure
In addition to the fact that buying is almost always a better financial idea, the truth is that some people simply like being able to drive a new car. If that describes you, then leasing gives you a new car to drive at a more reasonable cost than if you bought the same car outright. But what’s really appealing is that at the end of a two- or three-year term, you can switch to an even newer model.
If you tried this same tactic with a new car purchase, you’d likely be slammed with the depreciation on your old car. If your car has lost $10,000 in value due to mileage, and you paid $30,000 for it, you’ll have only $20,000 to put toward a car purchase. You can offset some of this depreciation by getting a good value on a used car that has already taken that large initial depreciation hit.
Down Payments and Car Choices
One major benefit with a lease is that there’s no down payment necessary. With a used or new car, experts recommend putting at least a little money down, with the money often coming from your trade-in. “No money down” auto loans often come with higher interest rates. If you can pay cash for the full amount and avoid a car payment, you’re even better off.
With leases, not only are down payments not always required, but they also aren’t as valuable. A down payment, which is called a capitalized cost reduction in the leasing industry, doesn’t lower the amount you pay in interest over the lease term. However, it does lower your monthly payment amount, so it is an option.
Leased Cars and Insurance
In general, you won’t pay more for insurance on a leased car simply because it’s leased. However, leasing companies often have very specific requirements when it comes to the coverage you’re required to keep on your car. If you don’t usually invest in comprehensive insurance to fully cover your vehicle in the event of an accident, you may find your insurance is more expensive with a lease.
Whether you’re going with a leasing company or purchasing a car, an accident could prove costly. In either situation, an accident could put you in the position of owing more on the car than it’s worth. Gap insurance covers the “gap” between what the car is worth after depreciation and the amount you still owe in payments on it.
Fees for Leasing a Car
If you take out a lease, your lease payments aren’t the only expense. You also need to consider the following extra lease fees:
- Interest: Yes, you pay interest on the car you’re borrowing. Lease interest is called the “money factor” or “lease fee,” and the rate you pay is typically based on your credit score.
- Sales tax: In addition to interest, your monthly payment covers depreciation of the vehicle. Sales tax is charged on both the interest and depreciation and is included in your monthly payment.
- Acquisition fee: This is the fee a leasing company charges for managing the lease. It is usually a few hundred dollars, but it can go as high as the $800 range.
- Disposition fee: This is a fee you pay at the end of the lease to prepare your vehicle to either sell or lease to another interested customer. It’s typically a few hundred dollars.
Fees for Buying a Car
You aren’t immune from fees if you buy a car, though. Even if you purchase it from a private owner versus a car lot, you have to pay to register it. Here are some fees you pay when you buy a car:
- Transportation and preparation fees: Some lots charge you a fee for preparing and transporting the car from one place to another.
- Administrative fees: These fees can cover all the ancillary tasks involved in transferring the car to you, including the paperwork.
- Destination charge: If you buy your car from a dealership, this fee is passed on to you and is non-negotiable. It’s the fee the manufacturer charged the dealer to deliver it to the lot.
- Registration and title: Unlike a leased car, a car you purchase must be registered in your name to legally drive it long term. The dealership usually handles this for you, but you have to do it yourself if you buy from a private seller. Registration and titling fees vary by jurisdiction.
If you take out a car loan, there are some fees in addition to the above. Here are some of the most common car loan fees:
- Finance charge: Your interest may be combined with various fees to become a finance charge. Fees can include all the costs the lender wants to charge to manage your loan. This is a percentage of the loan amount you’re requesting, usually the purchase price minus any money you’ve put down.
- Extras: If you don’t watch carefully, your loan could include extras like gap insurance or an extended warranty. You can easily sign on the dotted line without realizing you could have declined some of the purchases and paid less each month.
One of the best ways to avoid fees is to ask for the cash purchase price, then compare it to what you’re offered when you try to get the loan. Also, make sure you shop various lenders, including credit unions and online loan options. You can often get a much lower interest rate by getting the loan outside of the dealership.
Car Leases for Business Owners
There is one instance where leasing can be a better idea than buying. Business owners who purchase company cars can benefit from tax deductions related to leased cars. The monthly payments you make on a lease are deductible as a business expense, so you can save money this way.
In addition to potential tax savings, business leases can also relieve some of your headache, particularly if you have multiple employees. The leasing company can help you line up the insurance you need to protect your business if there’s an accident.
Trading in Leased vs. Purchased Cars
The best thing about buying a car is that you can eventually own it outright. At the end of your loan payments, the car is yours, and you can either trade it in on a newer vehicle or sell it. You can get much more by selling it since the car lot wants to make a profit after buying the car from you, but selling a car takes time and work.
One benefit of a leased vehicle is that the trade-in process is usually much easier. In fact, your leasing company usually finds ways to encourage you to trade in as you reach the end of your lease. To trade your leased vehicle, you just take it to the leasing company and complete the necessary paperwork.
Credit Requirements for Leasing vs. Buying
If your credit score isn’t excellent, that may influence the route you take. If you have enough money to pay cash for a vehicle, your credit score won’t matter at all. But even if you’re taking out a loan, you can find lenders who work with you if your score is on the lower end. For a good interest rate, you need a score of only 660 or better.
That requirement is higher if you’re leasing. This also varies by leasing company, but generally, your credit score needs to be 680 or better. A leasing company may also consider your income and other factors. If your score isn’t ideal, you’ll probably be required to make a down payment in the form of a capitalized cost reduction.
Read More: What Is a Prime Credit Score for an Auto Loan?
If you’re considering leasing your next vehicle, it’s important to weigh all the options. Get a quote for the full amount you’ll pay for your lease throughout the term and compare it to what you’d pay for the same car if you purchased it. You’ll often find that even with car payments, it makes more financial sense to buy a car than to lease one.
- Experian: What’s the Average Car Loan Payment?
- Credit Karma: How Much Does It Cost to Lease a Car?
- AARP: What To Do When Your Car Lease Ends
- Edmunds: How to Return a Car at the End of a Lease
- Cars Direct: Used Car Price Per Mile: Understanding What's Exceptional
- Cars Direct: Should I Put Any Money Down When I Lease a Car?
- Experian: Is Insurance on a Leased Car More Expensive?
- Allstate: What Is Gap Insurance And How Does It Work?
- Edmunds: Looking To Lease? Read Our Car Leasing Basics
- Investopedia: Money Factor
- Banzai: What a Car Loan Costs
- IRS.gov: Income & Expenses
- U.S. News & World Report: Buying vs. Leasing a Car
- NerdWallet: What Credit Score Do You Need to Lease a Car?
- Kiplinger. "Five Myths About Leasing a Car." Accessed Aug. 15, 2020.
- Nolo. "Car Leasing: Maintenance, Repairs, and More." Accessed Aug. 15, 2020.
- Internal Revenue Service. "Publication 463 (2019), Travel Gift, and Car Expenses." Accessed Aug. 15, 2020.
- Edmunds. "Looking to lease? Read our car leasing basics." Accessed Aug. 15, 2020.
Stephanie Faris has written about finance for entrepreneurs and marketing firms since 2013. She spent nearly a year as a ghostwriter for a credit card processing service and has ghostwritten about finance for numerous marketing firms and entrepreneurs. Her work has appeared on The Motley Fool, MoneyGeek, Ecommerce Insiders, GoBankingRates, and ThriveBy30.