Let’s cut to the chase: buying a used car can be the best financial decision you can make in most cases. But it’s not the only consideration. Other features such as technology or newness can take the front seat. You may also be wondering whether to lease or buy a car.
If this is you, let’s dive into some key considerations when it comes to leasing vs. buying a car before you head for the dealership.
The difference between leasing and buying a car
Leasing a car
Leasing a car is essentially a long-term car rental. You lease a car over a specified period of time and based on a specific agreement with the car dealer. Some reasons leasing a car may be attractive include:
- There is no overly involved or long sales process
- It requires a lower down payment
- You have the potential to trade-in for a new car every few years
- Your monthly payments may also be low than buying a car
Buying a car
When you buy a car you enter into a contractual agreement to make monthly payments over a specific length of time until you own the car outright. Buying a car may be a better option for some due to the following reasons:
- Complete ownership of the vehicle
- You can make changes to the car freely without breaching any contract
- Freedom to drive as much as you would like without considering limits on mileage
- You can resell the car once you’re done with it
The cost breakdown of leasing vs. buying a car
If you are unsure whether to lease or buy a car, a good place to start is with the costs. When considering the cost of leasing vs. buying a car, it's a good idea to dig a little deeper than the upfront advertised costs.
That’s because the numbers displayed only tell part of the story. You’ll need to read between the lines and think ahead when it comes to the true cost of your purchase.
Let’s look at some simple examples of how to do this math.
Calculating the cost of a car lease
To figure out the total cost of a lease, you can use this simple formula:
Total cost = your monthly payment x (the number of months in the lease contract-1) + the amount due at signing
Note that the number of months in the lease contract is less one because the first payment is typically charged at signing. Be sure to confirm this.
For example, let's say you want to lease a Honda with monthly payments of $199 for 36 months and $1,999 due at signing. The cost of the lease would be calculated as follows:
Total cost = $199 (monthly payment) x 35 (number of months in the lease contract-1) + $1,999 (amount due at signing).
The total lease cost for this car is $8,964.
When looking at lease offers, always keep the mileage limit in mind. If the mileage cap for the vehicle is really low, you may end up spending more money in the long run if you go over the mileage limits set in the contract. Here's a simple car lease calculator to help you run your numbers.
Calculating the cost of a car purchase
The cost of a car purchase depends on many things such as whether or not you’re paying in cash or if you’ve secured zero-percent financing. That being said, most people take out a loan to make a car purchase.
The easiest way to do the math on a car purchase is to use a simple car loan calculator. Calculators will typically ask for the car price, interest rate, and loan term. Once you enter this information, it will tell you the monthly payment.
To illustrate: Let's say a car you want to buy is priced at $20,000 and you have $2,000 for an upfront down payment. You are also trading in a car worth $4,000. In this scenario, you’ll only need to finance $14,000. We'll also assume that you are eligible for a loan with an interest rate of 5% over 5 years.
The formula is as follows:
Total cost = (your monthly payment x the length of the loan in months)+ your down payment + your trade-in value
Using an auto loan calculator, your car payments would come to $264 in monthly payments. And the total cost of the car would be: ($264*60) + $2,000 + $4,000) = $21,840
Keep in mind that buying a car can be more expensive in the short term than leasing. This is because your monthly payments may be higher with buying than they would be leasing. However, when all is said and done and you’ve finished paying off the vehicle, you'll own it outright. You can learn more about the different ways to save money on your car expenses if you decide to buy vs. lease.
Understanding the fine print of a car lease
On the surface, leasing looks pretty easy. However, the reality is that it may not always be that straightforward. If you’ve never leased a car before, you will want to go over the paperwork to avoid any misinterpretation. And accountants or an attorney can help you with this if you need the support.
If you breach the terms of your lease contract, it can result in significantly higher monthly charges for you. Here are some key items to watch for:
Car dealerships often place a limit on the number of miles a car can travel
(typically 12,000 – 15,000 miles). This is because they want to preserve the car so they can sell it in the future. Any violation of the lease requirements results in a surcharge (from $0.01 to $0.15 per mile, and sometimes more).
Wear and tear
If a car is returned at the end of a lease agreement with significant wear and tear, the lessee is responsible for repair and replacement costs.
Payment terms and penalties
Who is leasing a car best for?
The choice between leasing and buying boils down to what you think works best for you and your finances.
When you lease a car, you are essentially paying to borrow a vehicle that you don't have an ownership stake in. This is similar to renting an apartment. However, if you’re not looking for ownership, leasing may be right for you.
Additionally, for some, the thrill of driving a new car every few years without being tied to permanent ownership makes a world of difference. Leasing gives you this opportunity.
For business people who are considering leasing vs. buying, leasing offers more tax write-offs than a loan would, letting you maximize your tax deductions and ultimately lowering your tax bill.
The reason? Depreciation and financing costs are deductibles per the rules given by the IRS.
How to get out of a car lease
Stuck in a car lease? Sometimes, life happens and you might find yourself in a situation where you need to get out of your lease. There are essentially 3 ways to go about it, and they each
come with different cost implications. Let's go over them.
1. Terminate your lease early
Some leasing contracts offer an early termination option which will release you from your commitment to making monthly payments on the car. However, it also means that you have to turn in the car and to make payments due on including any termination fees and penalties.
One thing to keep in mind, if you’re still early in your contract is that your termination fees will be higher and may be more expensive than if you just finished the lease as originally planned!
2. Transfer your lease
Terminating a lease can be expensive, but there is another potential way out – transferring the lease. In many cases, you can find someone to transfer the lease to as long as they meet certain requirements.
In addition, if you don’t know anyone looking to take on a lease, there are third-party companies that specifically offer this service. Be sure to do your research, read reviews and determine any associated costs.
3. Buyout your lease
Another great way to transition out of a lease is to buy out your lease. You can do this by purchasing your car upfront. If this is an option, you can do the math to see if paying the buyout amount (plus any associated fees and taxes) and then selling the car makes sense financially.
A lease buyout works best if the market value of the car is higher than the leasing company’s estimated value of it. To determine what the leasing company valued the car at, you can look for the “residual value” in your lease agreement. As long as the market value of the car today is higher than the residual value listed in the agreement, you will be in a great position.
Can you purchase a leased car? (Lease to own)
As mentioned above, it is possible to purchase a leased car and there are valid reasons why you may want to do so.
For starters, if you buy your leased car, you have the fortune of knowing exactly where it’s been and what condition it’s in - which is not the case when buying a used car.
If you’ve treasured the car while leasing it, it may be a no brainer to purchase it when the lease is expiring. If, on the other hand, you did not handle it with care and you potentially face high fees and penalties for wear and tear, you may be better off purchasing the car.
Another scenario where purchasing a leased car makes sense is if you’ve gone over the mileage restrictions. There are often penalties associated with going over the mileage that may make buying your leased car cheaper.
So there you have it. While the decision between owning or leasing a vehicle is not a light one, your decision can be easier once you do the math! So do your research, shop around and run your numbers. You'll be on your way to driving the perfect car for you soon!