By Russ Heaps
If you are on the hunt for a new car, you may be weighing the lease-vs.-finance question. The primary difference is essentially renting versus buying. Monthly leasing payments satisfy a long-term rental contract, while monthly financing (loan) payments go toward eventual ownership.
Leasing contracts are typically shorter than loan terms, and leasing payments are smaller than loan installments. Both borrowing schemes have advantages and disadvantages, so how do you know which situation is better for your long-term financial goals? To help you answer that question, here are five things to consider before making the lease-vs.-finance decision.
1. Innovation or equity?
The principal disadvantage of leasing for the average person is that you have nothing to show for years of payments at the end of the lease. Leasing is renting. You turn in the car at the end of the leasing term, drop off the keys, and walk away.
On the other hand, the advantage of leasing is driving a new car every two or three years. When leasing, you always have a late-model vehicle with the latest technology, innovations, and new-car warranty protection.
When you finance a car with a traditional auto loan, you slowly build equity in that car. You eventually own it when you make the final monthly payment. So, those years of payments lead to something of value. In the end, you possess something you can touch and call your own.
At the end of the loan term, you are free to drive that car until the wheels fall off. Or, at some point, you might trade it in toward the purchase of another vehicle. With leasing, you have nothing. Over the long run, using a loan to buy a car makes more financial sense for the average consumer.
Especially for consumers on a tight budget, working a monthly new-car payment into the mix of other bills can be challenging. Lease payments are always less than loan payments. This is often true even if the loan term is twice that of the lease because you only pay for the car’s depreciation when leasing. In other words, you only pay for the value the vehicle loses when you have it.
Remember, leasing is renting, and financing is buying. You are paying for the car’s entire value when new with a loan.
For example, let’s say you picked a 2022 Nissan Sentra S for $20,835, including the destination fee. If you took Nissan (OTC:NSANY) financing for a 36-month loan with no money down, the payment would be $596 a month. Choosing the Nissan 36-month lease with $398 down, the monthly payment would be $348. Even if you financed for 60 months, the $384-a-month payment would be more than the 36-month lease.
No question: Leasing payments are lower than monthly payments for financed auto loans.
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3. Extra Costs
Again, leasing is renting, and you face various fees when you turn in the vehicle. At the end of the lease, you should return the car undamaged beyond normal wear and tear. That dent from a parking lot encounter or the chocolate milk stain from the kids on the back seat will probably cost you at lease-end. The dealer performs a purely subjective inspection. Anything can happen.
Every lease also has an annual mileage cap. You agree to drive a limited number of miles per year. For the Sentra example above, that cap is 12,000 miles a year or 36,000 miles for the three-year lease. For every mile you drive over those 36,000 miles, you will pay a $0.15 penalty. For example, if you turn in your Sentra at the end of three years with 38,000 miles, you’ll pay for a 2,000-mile overage. That works out to $300. The per-mile overage penalty can be two to three times per mile higher, depending on your lease.
At the successful conclusion of a traditional loan, you owe nothing. Regardless of the number of miles or the car’s condition, the vehicle is yours, free and clear.
Financing has the advantage here because, unlike leasing, you don’t need to worry about getting dinged with extra charges at the end of the loan.
A lease hamstrings the lessee who wants to customize the vehicle or get out of the lease early. The basic agreement of any lease is simple: You will return the automobile in the same condition it left the showroom at the end of the lease. In other words, you can’t add pinstripes, custom wheels, upgrade the audio system, or any of the hundreds of other things people do to customize their ride. Altering the vehicle will cost you money when the lease terminates.
When financing with an auto loan, you can dispose of the car whenever and by any method you choose if you pay the lender the loan’s outstanding balance. You may trade it, sell it, or give it away. However, you must settle the balance with the lender. Getting out from under a lease is much more complicated and often expensive. Every car lease almost always has an early termination penalty. It may be as much as the remaining monthly payments or some other punitive amount.
Although there are a few online lease brokers like SwapALease that pair lessees who want out of a lease with people willing to assume a lease, there is still a cost. Moreover, not every contract allows for transferring a lease to another party.
5. The long run
Although this is somewhat of a callback to the “Innovation or Equity?” topic, it’s worth noting that the value you get from a vehicle you own may continue long after the loan ends. Whatever value you receive from a lease ends the moment it terminates. If it’s a two-year lease, the value stops in two years, three years for a three-year lease, etc.
When you finance a car with a loan, you may continue to drive it years after making the last payment. It remains valuable each additional year you drive it. You may even hand it down to a family member who will continue enjoying its value.
Our advice up to this point is for the average consumer. You may fall outside that category, and leasing makes solid sense under certain conditions.
Leasing can benefit individuals or businesses that use a vehicle as a tax deduction. A leased vehicle may translate into a larger deduction because of how the lease is structured. Your tax professional can fill in the details for you.
There are occasions when you know you will only require a car for a finite amount of time. Perhaps you have a long-term temporary job assignment across the country requiring you to be there two weeks each month. It may make more sense to take a two-year or another short-term lease rather than hassling with renting a car for two weeks each month.
Some drivers want a new ride every couple of years without the hassle of selling or trading the current car. Leasing streamlines disposing of your current vehicle, and it also guarantees what that car will be worth at the end of the lease. Your lease contract states the value the leasing company places on that car at the end of the lease. It’s known as the “residual.” If the vehicle is worth more than the residual at the end of the lease, you have other options to take advantage of that. However, if the car’s market value at the end of the lease is worth less than the residual, you are off the hook. You turn the car in and lease another.