A recent deep-dive into the true costs of car ownership found that the average car owner logs 13,500 miles on their car every year. That number of miles can put big-time stress on your vehicle and cause costly repairs, not to mention the additional expense to register, insure, and fuel your car.
Because these costs are tied to a depreciating asset, decisions on buying or leasing a car can feel confusing. A new survey from Experian illustrates another reason why many car buyers become car lessees. The average monthly new-car payment clocks in around $725, a good bit higher than the average lease payment at $586.
With all the fine print in buying and leasing contracts, it’s a hassle to choose the best way to acquire your new vehicle. The volatile vehicle market has challenged many longstanding assumptions over the past few years, as proven by the soaring resale value of many used cars.
If you have a strong opinion on this personally, you might benefit from digging in with a professional to challenge how what made sense even a decade ago might not hold true today.
So, should you buy or lease a car?
How Do Car Leases Work?
Leasing a car operates along the same lines as renting a house. You make an upfront payment (similar to a security deposit on a rental) and then you pay your monthly payments at an interest rate in the contract.
Your lease agreement will sketch out all of the loan terms, including how long the lease will last (likely that’s 2-4 years). It will also give guidance on how much the car is expected to be worth at the end of the lease contract, and if there will be any other fees due at the end of the lease term.
Lease agreements also lay out any penalties you could incur if you want to end your lease early, or if you miss your lease payments. There could be caveats on how many miles you drive a year, or how much wear and tear you can put on the car. Be sure to know the details of the agreement so you can avoid hefty fees.
An easy myth to bust up front is that you don't need to buy insurance when you're leasing. To the contrary, agreements will dictate what is necessary, likely comprehensive & collision coverage.
Although insurance is required whether you plan to lease or own, the agreement requirements may be higher than what you planned, something to consider in your personal calculations.
What Are The Benefits of Leasing a Car?
Leasing offers a few distinct advantages over buying. The main draw for many lessees is the lower monthly payments, and usually a lower down payment as well.
Leasing also offers some customers the ability to use a much nicer vehicle than they would’ve been able to purchase on their own and the flexibility to upgrade their vehicle more often if that is important for you. (Vehicle technology progresses quickly these days!)
It also can save you money on some maintenance costs, especially the unexpected kind. Because you’re generally leasing a new car only for a few years, years when the car is still likely to be under the manufacturer’s warranty, the likelihood of pricey repairs is mitigated. In fact, many lease agreements include certain repair costs.
A leased car also means that you won’t have to worry about selling or a trade-in when you’re ready for a new one. And it can even be more cost-effective if your credit score has taken a hit and you can’t afford to do a shorter-term auto loan.
High interest can make the total cost of buying significantly more than leasing, particularly if you are edging into loan terms over 5 years. Just like with traditional trade ins, dealerships may offer incentives at the end of your lease if you decide to lease again.
To recap, depending on the terms and your plan, leasing may benefit you in mitigating the expense of down payments, maintenance, and the eventual impact of depreciation.
When Is It Better to Buy a Car?
In the last few years as the market shifted due to decreased supply and a higher interest rate environment, your long-standing assumptions about whether to buy or lease might be challenged.
Still, whereas leasing is a perpetual expense, the main advantage to buying is the ability to completely pay your car off and have no car payments.
Even if you have higher monthly payments for a time, buying should save you money in a long-term view, particularly if you plan to own the vehicle for a while.
When you buy, your car is an asset that you can sell or trade at any time. Although unlike real estate, it is a depreciating asset, you’re not stuck in a lease term with penalties on how you can use the car, which can tack on extra fees over time.
Interested in modification? Buying is the only option for car enthusiasts who want to soup their car up or modify the exterior in any way.
If you’re driving your vehicle a lot, any savings through leasing may not be realized when you're in a contract with a mileage limit of 10,000-15,000 miles per year where going over incurs large penalties.
To recap, benefits to buying are ability to pay off, no restrictions on mileage or modifications, and ownership of an asset that gives you a bit more flexibility, despite the reality of depreciation.
How Does Leasing Affect My Financial Plan?
Leasing may be a very attractive option due to the low payments, the ability to use a newer vehicle, and lower maintenance costs. But it can still have significant impacts on your financial plan.
The most significant impact is that it costs more, in the long run, to continually lease vehicles and the reality is you will never own an asset at the end of the lease.
Additionally, lease cost can skyrocket if you don’t follow the terms exactly. If you miss payments, modify your car, go over mileage or end up getting some dings or dents, the cost of leasing rises.
But that may not be the most significant penalty. The Federal Reserve Board reported that early termination fees could be extremely costly. If you call it quits early you could have to pay the difference between your balance and the actual value of the vehicle.
For example, If you have a three-year lease with a payoff amount of $35,000 and the vehicle’s actual value is only $31,000, you could end up shelling out $4000 in an early termination fee.
The Bottom Line
So given the pros and cons of each option, what's the bottom line?
It really depends on your needs, goals, and current financial situation. The calculation will look different for a person who has a smaller budget but desires a newer car in an urban area where they don't plan to drive long distances compared to someone who uses their car to travel long distances and has the budget to make a down payment and larger payments in the short-term.
In the cases where it doesn't feel clear cut, chatting with an objective third party like your financial advisor can be very beneficial. They can help you gut check your assumptions as well as the reality of the current interest rate and re-sale market to see what makes sense for you.
What Car Payment Can I Afford?
There’s a laundry list of pros and cons behind buying or leasing a car. Each situation is different and you may find that leasing a car is the best solution for your current situation.
If you're looking for a bit more guidance, check out this great episode of The Long-Term Investor, hosted by our Chief Investment Officer, Peter Lazaroff. Jesse Cramer, author of The Best Interest, joined Peter to discuss the astounding math behind car ownership.
Once you've made the call on a path that makes sense for you, you might be wondering how much car you can afford.
We compiled a handy guide to making that call in this blog. But because there can be significant financial impacts from leasing (and from buying as well) it’s important to consult an advisor to see how much you can really afford.
A financial advisor can get to the core of your financial situation and give you real-world advice on how to acquire your next vehicle. Contact us today to see how we can help.
