Car Leasing 101
So, you are in the market for a new vehicle, huh? You've got some important decisions to make. New or used? Coupe or sedan? Import or domestic? Fire engine red or metallic silver?
But perhaps your most important decision, at least from a financial standpoint, is how you will pay for the vehicle. You have three main options: pay the full vehicle price in cash, borrow money to pay for the vehicle, or lease the vehicle.
About one out of every four new vehicles that is sold today is leased, according to Edmunds.com. So, while leasing is popular, most car buyers still prefer to pay cash for their vehicles or finance them. To decide which option is right for you, you need to understand the details and nuances of each.
Paying In Cash and Vehicle Financing
From a pure cost standpoint, paying in full without financing may be the smartest option — if you have enough cash. Of course, that is a big if given that the average price of a new car today is about $34,000.
When you pay cash for a vehicle, you will not incur any interest cost as you will if you finance the vehicle. Of course, interest on a car loan increases the total price you end up paying for a vehicle. Depending on the loan's interest rate, this could add thousands of dollars to your eventual cost for a vehicle.
However, it is worth noting that with interest rates still at or near historic lows, financing becomes a more attractive option when compared to paying cash for a vehicle if you qualify for a low rate, like 2%-3% or lower. This could enable you to invest the money you would use to buy the vehicle outright in instruments that could earn a higher return than this. Alternatively, you could use this money to build up an emergency savings account for a possible rainy day in the future.
Also, keep in mind that dealers sometimes make zero percent financing offers to qualified buyers. Therefore, if you qualify for one of these offers, it will almost certainly make more sense to take advantage of this free financing than to use your own savings to buy the vehicle outright. Your credit score will affect what interest rate you qualify for. You can check your credit score and read your credit report for free within minutes using Credit Manager by MoneyTips.
One compromise strategy is to pay for half of the vehicle's price in cash and finance the other half. This will cut your monthly payment and the total amount of interest you pay approximately in half.
A final thought about financing: Most dealerships will offer financing to help you purchase a vehicle, but it often makes sense to examine other loan options before you visit the dealership. Having your financing lined up ahead of time can put you in a stronger position when negotiating the price of the vehicle. If you are interested in an auto loan, visit our curated list of top lenders.
How Vehicle Leasing Works
Leasing is a very different way to pay for a new vehicle. In effect, you are paying for the right to drive a vehicle for a certain number of years, or the lease term. When the lease term expires, you can return the vehicle to the dealership and lease another new vehicle, or purchase the vehicle if you want to keep it. (Of course, then you'll have to decide, should I pay in full or finance?)
When you lease a vehicle, you will usually make a down payment and then sign on for monthly payments over the lease term, which is typically three or four years. Car lease payments are usually lower than car loan payments because you are only "borrowing" the difference between the vehicle's value when it is new and its value at the end of the lease, or its "residual value".
However, if you turn the vehicle in at the end of the lease term, you own … nothing. The money you shelled out in a down payment and lease payments for three or four years bought you nothing more than driving privileges. You will have to pick out another vehicle, make another down payment, and start the lease process all over again.
Which Option Should You Choose?
Here are five questions to help you determine which option is the right one for you:
1. Do you like getting a new vehicle every few years? If you are one of those people who always wants to be driving a new car with all the latest bells and whistles, then leasing is probably your best bet.
2. Are you OK making a car payment every month indefinitely? But if so, remember that you will never own a vehicle outright — you will always have a monthly lease payment.
3. Is it important for you to own your vehicle outright eventually? In this case, you should pay cash for or finance a vehicle. Then you can drive it until the wheels fall off if you want to.
4. About how many miles do you drive per year? Most leases place a limit on how many miles lessees can put on a vehicle each year. If you exceed this limit, excess mileage charges will be assessed, which can significantly increase your leasing costs. The more miles you drive, the less leasing is attractive.
5. Will you use the vehicle for business purposes? If business purposes will account for a certain percentage of the vehicle's use, the lease payments could be deductible, thus lowering the overall cost of leasing.
You need to answer these and other questions and crunch some numbers yourself to decide whether you should pay cash, finance or lease your next vehicle. Happy car shopping!
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