This is an interesting question that depends upon your situation. The question really is do I want to own this vehicle or rent it?
Leasing a vehicle costs less than purchasing meaning the monthly payments is lower. Also there isn’t a down payment required. This can make getting a new car easier.
How does leasing a car work?
Leasing a car costs less than purchasing the same vehicle because you only partially amortize the purchase price whereas a loan amortizes the full purchase price.
What the heck does that mean!?!
Where you are dealing with cars and car purchases there are three things to keep in mind.
- Equity. This is the amount of the car that you own. As you pay off a loan you are repaying an amount of interest plus a portion of the principal or the amount of the car.
- Interest. Any loan usually comes with interest. The final amount of a loan is based upon the original price of the car (principal) plus the amount of interest to be repaid over the length of the loan. This can be a significant amount.
- Depreciation. They longer and further you drive your car the less it is worth.
To purchase a car you must pay for all three of these things. This can be very expensive. The other option is to rent or lease the vehicle.
When you lease a vehicle you will never own the car. Very much like renting a car you must return the vehicle to the dealership on a specific date so that they can resell the vehicle.
When a lease is established the dealership determines how much they think they can sell the vehicle for at the end of the lease. This amount is deducted from the price of the vehicle to determine the amount of the lease.
Since you are not repaying the full amount of a car the amount to be financed is lower and so are the monthly payments. This can be a real advantage for you if you are on a budget.
To better understand lets consider the example of purchasing a $20000 car over years versus leasing the same car. We will assume 10% interest in both cases as well as $1500 depreciation per year.
To purchase the vehicle you would have to pay $424.94 a month To lease this vehicle you would have to pay $159.35 a month.
How is this possible? This is possible because you are only leasing $7500, $1500 for each of the five years. That means to own this vehicle you would have to pay $12500 at the end of the lease or go find another vehicle.
Is leasing a car a good idea?
Leasing can be a good idea if you are willing to loose money. Leasing works very well for companies that have large fleets of vehicles where the continual maintenance costs may be greater than the amount lost due to leasing.
For an average consumer you will want to think carefully about this decision. Keep the following things in mind while trying to decide what is best for you.
- You are paying the dealership the amount of money they would have lost in depreciation if they could not sell the vehicle. This may help them more than it will you
- Leasing will not help your credit as much as purchasing. It is true that making regular payments do help your credit rating. In this case you will have a loan that lowers your maximum credit available and you will not have an asset to show for it. At the end of the lease you have a credit score that is a little better but not by much as you have no assets to secure a loan with.
- The number of miles per year you are allowed to drive is fairly limited. If you go over the limit you will be charged just like at a car rental company. Often the fee is $0.25 a mile. This can mean a huge bill.
- Since you will not have a vehicle when the lease is up you will have to also save money for a down payment on another car. If the amount of the lease is high this may be hard to do forcing you into another lease or having to pay much more since you do not have a trade in or large down payment.
What should I be aware of when shopping for a lease?
- The value of the vehicle at the end of the lease may be hard to accurately determine. It may be safe to assume that the dealership will error in their favor meaning they make more money when they resell the vehicle. Ask questions and negotiate if possible on the resale value.
- Gap insurance is a must have. Gap insurance covers the difference between the value of the car and the amount that you owe. In some cases the dealership, who really owns the vehicle while you lease it, will lease the vehicle to you for less that the difference between current value and resale value in order to lower your payments. Thinking of our previous example, let’s say we had an accident and destroyed the car. The car was almost 5 years old and according to the insurance company it is only worth $10000 which they pay to the dealership. You only leased $7500 meaning the dealership is short $2500 that you are liable for. Gap insurance covers that $2500.
- Do not make a down payment on a lease ever. You are not buying the vehicle hence the lower price and refundable security deposit. If you have money make a large security deposit payment. This will have the same effect as a down payment in that it reduces the total amount that must be leased but you get it back at the end of the lease with some interest.
- Never get optional equipment in the leased vehicle. You will pay the full amount of the value of these items meaning whoever buys you car after the lease is up gets these features for free.
- Never lease a car beyond it comprehensive warranty. If you do you may end up with costly repair bills on a car that you don’t own.
To lease or not to lease?
Leasing is a good option if you plan on keeping a car for less than 4 years, do not do a lot of driving and can afford to not own the car at the end. Examples might include if you are going to school for a year, if you may be moving abroad soon or if the future of your current job is uncertain.