Financing vs Leasing a Car: Which Is Better?
We all want to feel like we're walking away from a car transaction with the best deal possible. If you're weighing financing options for your new car, you're probably getting lots of advice from well-meaning friends and family. Some will tell you that financing a car is the sure bet. Others will swear by leasing. How can you know the best way to come out on top with the lease vs finance car question? It takes digging deeply into both options to find out.
What Is the Difference Between
Leasing and Financing a Car?
The simplest way to look at lease vs finance is that it comes down to paying for the value you use while a car is in your possession vs making monthly installment payments for a car you are buying. Both come packed with their unique pros and cons. Your lifestyle, long-term goals, and the risks and rewards of car ownership will all help you decide which option is best for you.
Leasing a Car
Leasing a car essentially means that you're "renting" a car for a fixed term. However, there are some stipulations weaved in that make this very different from picking up a ride at a local rental agency. With leasing, you'll make monthly payments to keep possession of a car through your lease term. You'll then return the car at the end of your term. Something that attracts many people to leasing is that you're typically making smaller monthly payments compared to standard car payments. This mostly has to do with the fact that you're not responsible for covering the principal the way you are when you borrow money for a car loan.
How Do Car Leasing Contracts Work?
You may be wondering how car leasing companies decide on monthly lease rates. Leasing a car means that you're actually borrowing and repaying the gap between the car's full new-car value versus the car's expected value when your lease ends. Leasing companies will also tack on some financing charges. Use GoodCar's lease calculator to figure out how much you will be paying. Leases are affected by many factors such as term, API rate, incentives, and sticker price.
Leasing prices also vary based on how many miles you expect to drive. You'll need to choose a mileage option based on the anticipated number of miles you'll drive during your term. However, the "catch" is that you'll be charged for any extra miles you tack on unless you decide to ultimately purchase the vehicle. Yes, you can buy a car after the lease ends. This is known as a lease buyout.
The process for a lease buyout will vary based on the specifics of your contract. You'll first need to confirm that your lease agreement does provide a buyout option. Next, the general process for a lease buyout is that you'll agree to pay a price for the car that's based on its residual value at the time that the lease is up. Some leasing agencies will refer to this as the "purchase option price" in your contract.
The buyout option typically comes with some additional fees. In fact, a lease buyout is often considered to be a pricier-than-average option for buying a car. That's because the newness of most leased cars means that they retain pretty high residual values. Why do people do it? Ultimately, some people just like the convenience after falling in love with a car they've been driving for a while. Like any car purchase, a lease buyout purchase allows the buyer to use either cash or financing.
What Are the Pros and Cons of Leasing a Car?
It's natural to question if a car lease is the best option when you don't actually walk away with a car under your ownership after paying money. Looking at the full-picture benefits of leasing can help you to understand why some people might choose this option. These are the pros of leasing a car:
- You get to drive the latest model with a robust new-car warranty.
- You can get access to a high-priced, fully-loaded vehicle that might not be in your price range if you were to purchase a car.
- You get to drive a new car that's likely to be free of troubles.
- Your car is likely to have all the latest safety features.
- Some leases provide free scheduled maintenance. That means not worrying about the cost of oil changes.
The advantages of leasing a car can be compelling. However, it's important to look at the flip side to find out why most people steer clear of leases. These are the cons of leasing a car:
- Lease costs can often be equal to loan costs simply because you're paying a monthly rate based on the difference of full value versus residual value.
- Leasing one car after another puts you in a position to make monthly payments in perpetuity. By contrast, financing a car allows you to pay off the car to enjoy many years of payment-free driving. The general rule is that driving a car for as long as possible after it's paid off is the smart financial choice. Making regular monthly payments on a car can make it hard to save for other things.
- Lease contracts can trap you with limited miles. Penalties for excess mileage can be hefty.
- Most people don't realize that leasing contracts require drivers to pay charges for excessive wear and tear if the car is looking a little rough when it gets turned in.
- Leases come with early termination fees. These fees sometimes total the full lease amount.
- While lease agreements take care of general maintenance, most keep you responsible for expensive replacement items like tires. If you're leasing a fancy car, the cost for tires and parts can be high.
- You'll pay sales tax on your monthly lease payments in most states.
Leasing can feel a bit like getting some added luxury and convenience in exchange for not getting to the "end point" with monthly payments. While there is the option to purchase a lease car that you're smitten with, a lease buyout is not the most affordable way to buy a car. Of course, you can't decide about finance vs lease car until you dive into the pros and cons of financing.
Financing a Car
Cars can be financed through either direct lending or dealership financing. The goal with both is to make monthly payments on a vehicle until owning it outright. Most people put down between 10% and 20% of a car's price before financing the rest. Loan terms generally cover 24, 36, 48, 60, 72, or 84 months.
What Is Direct Lending When Buying a Car?
With direct lending, you're getting a traditional loan from a bank, credit union, or other financial institution. Your car loan will require you to pay your financed amount with any applicable charges over a specific period of time. The perk with direct lending is that you can actually get authorized for a loan before you start shopping for your car. Showing up with knowledge about your future loan's terms, annual percentage rate (APR), repayment term, and maximum borrowing amount can empower you to focus on the right cars at the right prices. Use GoodCar's loan calculator to empower yourself.
What Is Dealership Financing When Buying a Car?
Using dealership financing means that you're applying for a car loan through the dealership where you're purchasing your car. You'll enter into a contract with the dealer that specifies a financing amount, financing charge, and repayment period. While you're negotiating directly with the dealer, it's very likely that your contract will be sold to a bank or credit union that will be collecting your monthly payments.
Going with dealership financing doesn't necessarily mean being stuck with limited options. Dealerships often offer several financing options to buyers because they have partnerships with different lending institutions. You may even be able to tap into limited-time manufacturer offers for low interest rates and special incentives. However, these perks can often be rigid regarding the specific cars that qualify. You might also need to show up with stellar credit to be able to be approved for special offers.
The Pros and Cons of Financing a Car
The biggest perk of financing a car is that your repayment period on the loan will end. You'll then have full ownership of a car with no strings attached! Many people look forward to this day because they can begin putting the money they were spending on car payments toward other goals. Here's a full rundown of the benefits of financing vs leasing a car:
- You can keep the vehicle for as long as you want!
- You don't have to stress over spills, dings, dents, odors, and other small imperfections that could result in fees if you had to return a leased car.
- You have no mileage restrictions.
- You can sell or trade in your car at any time without penalties.
- Your paid-off car can be considered equity you can use toward your next car purchase.
People who value tangible assets tend to prefer buying over leasing. However, it's still important to know about the downsides to ownership even if you're pretty sure that financing is the route for you. These are the cons of financing a car:
- Unlike the automatic "handing off" that happens at the end of your term with a lease, selling or trading a car you own requires some work.
- Every vehicle depreciates.
- Monthly car payments are generally higher than monthly lease payments.
The big takeaway is that a car really feels like it's yours when you purchase through financing. While you may not be able to step into a car that's quite as luxurious as one you'd be able to drive using a lease option, there is that special feeling of knowing that you "did it".
Frequently Asked Questions
Can You Buy a Car After You Lease It?
Yes. This is called a lease buyout. Leasing companies will allow you to either finance or pay cash for your car if you want to keep it. However, it can be hard to get a good deal using this option because a leased car's purchase price is based on the gap between new-car value and residual value.
Is It Cheaper to Buy or Lease?
Monthly lease payments tend to be lower than monthly car payments. However, fees and penalties can actually make a lease much more expensive in some situations.
What Is the Difference Between Financing and Leasing a Car?
Leasing a car means that you're making monthly payments for the privilege of driving a car a set amount of miles for a set period. While you'll never own the car, you can sign up for a new car lease each time a lease ends. Financing a car means making monthly loan payments at a specific interest rate for a particular term until you own the vehicle. Car financing works in a very similar way to how a home mortgage works.
What Happens If You Drive Your Lease Too Many Miles?
If you go over the miles in your lease contract, you will be charged for every mile you go past your limit.
Do You Pay for Maintenance on a Leased Car?
Many people are surprised to learn that it's common to pay some maintenance and repair costs on leased cars. However, most leased cars are newer cars still covered by a manufacturer's warranty. Many lease agreements also throw in oil changes. That doesn't mean that you won't ever be on the hook for replacement parts and repairs.
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