It is that time of the year when the weather is nice and people think about buying a new car. I’ve had a few friends lately tell me they were going car shopping and given what I do for a living, they had some questions for me. In fact, I get the same questions from clients: Should I buy or lease a car? These are simple questions to ask but not always easy to answer; it all depends on your personal circumstances and preferences. Before I discuss any further, let’s not forget that any money spent on a car is an expense, not an investment. So once you start treating it as such, it is much easier to accept the cost of owning or leasing a car. In my opinion, the most important thing in making a decision is to understand the differences between leasing and buying and choose the one that matches your personal situation—including your budget. Consider the following:
Who owns the car?
When you buy a car you usually pay for it with cash or obtain a car loan. The car is an asset of yours and when paid off you can keep it, trade it in or sell it yourself. When you lease a car, you must return the car to the dealer when the lease term has ended or buy it from the dealership at the residual value (i.e. buyout option) which is calculated prior to entering into the lease agreement.
What are the payments?
When you purchase a car, your monthly payment is based on the price of the car minus any down payment you put towards the purchase. The size of the monthly payment is determined by the size of the loan, the length of the loan, interest rate on loan, sales tax, registration fees and any other charges. Leasing is like renting a car but for an extended period of time. When you are leasing a car all you are really doing is paying for the depreciation of the vehicle for 24, 36 or 48 months. So in its simplest terms, if a car is worth $30,000 upon purchase and the residual value is $20,000, then your lease payment will be $10,000 divided by 36 months. While that may seem a bit too easy, it is. The lease payment in most states will also include sales tax, finance charges, registration and title fees. Either way, because you are paying for the depreciation of the car and not the entire purchase price of the car, the lease payment is usually lower.
Is there a down payment?
When you purchase a new car, you usually need to put money down on the car or trade-in your car as part of the down payment. In most states, the advantage of trading in your vehicle as opposed to a cash down payment has to do with sales tax. When you trade in your car the sales tax is calculated based on the purchase price minus the trade in. All a cash down payment does is reduces the amount you are financing. Given the price of cars these days and the sales tax percent, this number is usually rather significant.
You are usually not required to put money down when leasing a car. You may be required to make a few payments up front but that depends on the dealer. If you don’t have the money for a big down payment, leasing might work best for you.
What is typical mileage allowance?
When you purchase a car you can clearly drive it as much as you want and put as many miles on it as you would like. This will depreciate the value of the car so in a sense it does cost you, but no money comes out of your pocket immediately.
On the other hand, when you lease a car you are usually limited to 10,000, 12,000 or 15,000 miles per year. The higher the mileage you agree to up front, the larger your monthly payment will be because mileage depreciates the value of a car. If you go beyond the mileage agreed to up front, then you pay extra for each mile you drive over and above that number. This can get rather expensive. But you also do not want to agree to a high mileage lease if you don’t think you will drive that many miles because you won’t get any money from dealer for not using the miles. It is important to find out the cost of each mile over and above the agreed amount and compare to how much more you pay each month for a higher mileage lease. It may be cheaper to pay the penalty for going over the miles than paying for more miles up front. You just have to take the time and compare these numbers.
How well do you take care of your cars?
When you purchase a car, you can treat the car as you wish. The condition of the car is irrelevant because it is your car and you can repair things or let them stay as they are. No one cares what condition your car is in other than someone who wants to buy it or a dealer who takes it in as a trade.
This is not the case when you lease a car. The dealer has to take your car back and resell the car at the end of the lease term. If you have a lot of dents, scratches or other problems with the car other than normal wear and tear, it can result in a lot of extra fees upon returning it to the dealer. If you are the type of person who takes care of your car then this will not be a problem for you if you decide to lease. Remember this: you can purchase the car from the dealer at the end of the lease term, and in some cases, this can be a really good deal for you especially if you have taken good care of the car and it is worth more than the residual amount.
What if I want a new car every three years or so?
If you buy a new car every few years it takes a lot of work to either sell it outright to a private party or trade it in to a dealer. Most people do not like the car buying experience in the first place because of all of the negotiating and the time it takes to get the deal you want.
Leasing is basically for people who want to drive a new car every few years. Once your lease has expired, you take it to the dealer and hand it over, hopefully with no penalties or extra fees, and get into a new car lease. Dealers try and make it as painless as possible for the consumer. If this sounds like you then leasing may be for you.
So what should I do?
The above are some of the factors you should consider prior to making the decision between buying and leasing. Statistics show that most people still prefer buying over leasing, so leasing is still new to many. Given that I am a financial advisor, I want to see people focus on their budget when making a financial decision, but I am realistic enough to know that other factors come into play. So at the very least, write down the various differences of buying and leasing as I outlined above before making your decision. Don’t let the dealer or even a friend make the decision for you because your personal situation matters. If you engage in this exercise, regardless of what you decide, at least you will be comfortable knowing you went through a well thought out process.
The information contained in this post is not intended as investment, tax or legal advice. StrategicPoint Investment Advisors assumes no responsibility for any action or inaction resulting from the contents herein. Rick’s opinions and comments expressed on this site are his own and may not accurately reflect those of the firm. Third party content does not reflect the view of the firm and is not reviewed for completeness or accuracy. It is provided for ease of reference.