My old jalopy is about to die on me yet again, so it's time for a new car. I'm wondering if I'd be better off leasing my next car instead of buying it. Which is the better deal, leasing or buying with an auto loan?
Need a New Ride
Since buying a car is one of the biggest purchases you can make, it's wise to take a look at all your options. Both leasing and buying have advantages and disadvantages, just like renting versus buying a house.
The most obvious difference is that with a lease, you get a new car every few years and don't have to deal with the hassle of selling the car later; just hand the keys over to the dealer and get a new lease.
When you buy a car, on the other hand, each payment you make on a financed car builds equity; once you pay off the loan, it's yours free and clear and you can sell it (or donate it) for something later. (If you buy a car outright without a loan, you save even more money.)
Since you asked primarily about which makes the most financial sense, here's how to figure that out and more considerations. As an example, let's look at the cost between buying or leasing a $20,000 car for five years, assuming the same 6% rate on a new car loan (paid off in 3 years) and the lease (two 3-year leases), and driving 12,000 miles a year (numbers provided by Edmunds).
1. Your monthly cash flow: Leasing a car often has a lower monthly payment compared to financing a car with the same loan terms, since with a lease you're paying for the depreciation of the car during those years rather than the whole vehicle cost. If you need access to more cash every month, leasing may be more favorable.
In our example, the car loan monthly payment is $608 a month; the lease is $350 a month for the first 3-year lease and then $385 a month for the last two years (because a second lease is initiated).
2. Available savings for a down payment and initial fees: Most lease agreements have low downpayments or you can get the dealer to waive the downpayment, and you'll pay less for the sales tax on a lease as well (the tax is calculated in most states only on the monthly payments, not the total cost of the car). As with the lower downpayment, leasing has a smaller impact on your budget and cash balance.
Example: $3,000 downpayment for the loan versus $2,000 for the lease.
3. How much you drive: If you drive a lot—over 10,000 to 15,000 miles, depending on the lease agreement—you'll probably have to pay extra for each mile. Smart Money says that many leasing companies charge 15 to 20 cents a mile for additional miles, but you could pay less (10 cents per mile) if you buy them upfront when you negotiate the lease. Kiplinger notes that although the extra mileage penalty sounds daunting, if you plan on trading in a car you bought, you'd be penalized for above-average mileage too.
This example doesn't have any extra mileage fees, but if you drove 5,000 miles over the agreement, at 20 cents a mile, that would cost you $1,000.
4. How hard you are on the car: If you're prone to getting scratches on your car or have a high risk of damage to it from kids or other hazards, a lease may not be for you, because of the wear-and-tear fees. Wear and tear fees vary and would depend on your agreement, but Lending Tree says these are typically limited to the total of three months' lease payments.
Our example also doesn't include wear and tear charges, but if you weren't able to keep the car pristine, three months' payments in this example would be $1,155.
5. If you drive the car for business: When you lease, a portion of the car's depreciation and financing costs can be deducted on your taxes. Interest on loans to buy a car, however, aren't deductible. The IRS has a guide for how to calculate the tax deduction for a leased car (there are a lot of calculations based on your business percent use of the car, how much the car costs, and additional expenses related to the car, such as gas and maintenance).
6. How long you plan on keeping the car and how flexible you need to be: This is a big consideration, of course, since if you really only want to drive the car for a few years, leasing is the most convenient option. However, you'll pay a lot if you try to get out of the lease before the term is up—as much as six extra months of payments, according to Smart Money. You'll need to be sure you can stick with the terms of your lease.
The reality: Buying a car is almost always cheaper in the long run, according to most calculations, such as this one from Cars.com. The longer you own the car, usually the more you save by buying.
In our example, at the end of five years, leasing a car cost $6,752 more than buying (assuming the car value at the end is $7,000)—$1,350 more per year to lease.
There are other considerations, such as lifestyle ones (do you want to always have the latest auto tech?) and avoiding having to deal with hefty repair bills for an older car, in which leasing may seem more favorable, or whether you want to avoid confusing terms and agreements (buying may be better). If you just want a quick calculation on which makes the most financial sense, use a leasing calculator:
The buy or lease calculator on Dinkytown includes factors such as annual depreciation, loan and lease fees, and interest you could earn on the money you save upfront by leasing.
Bankrate's auto calculator is another useful tool. The wizard that asks you things like how well you maintain your cars and what your credit rating is like.
In the end, your decision will come down to your budget and your driving needs, but we'd almost always recommend buying over leasing. Good luck with your decision!
P.S. There's a lot that goes into this, so if you have any other tips or advice about deciding between buying vs. leasing, share them with us in the comments.
Photo by Palto/Shutterstock.