When it's time for a new car, several options are on the table, from choosing the make and model to the various trim options. However, one critical decision during this period is choosing between financing (buying) the car or leasing the car. It helps to understand the pros and cons of leasing vs. financing a car and what these options entail.
Financing Vs. Leasing: The Key Difference
When buying a vehicle through financing, it's with the understanding that you'll own the vehicle at the end of the finance term. With a lease agreement, the vehicle is returned to the lessor at the end of the term.
Pros Of Financing A Car
One primary benefit of financing a car is that the payments go toward owning the car, which is considered an asset. Other potential pros of buying a car include the following:
- Ownership: Once the buyer pays that final installment at the end of the finance term, they can decide what happens to the asset. They can keep it for as long as they want or sell it. There's no obligation to trade in or sell the car at the end of the term.
- A car owner can customize the car: Buying a car means being able to modify it without worrying about it since the car isn't returned to the dealership at the end of the term.
- There are no mileage limits: For those planning to put a lot of miles on the car, financing it might be more cost-effective. There are no fees charged at the end of the term, regardless of the miles on the odometer.
- Excess wear and tear won't attract a penalty cost: Wear and tear are to be expected when using a car. However, when you're financing a car with the intention of owning it at the end of the term, you don't have to worry about covering expenses for excess wear and tear.
Cons Of Financing A Car
Cost is a factor when buying a car and can be considered a drawback. Other potential cons of buying a car are:
- Depreciation: Depreciation is the drop in value your car experiences from when you buy it to when you sell it. Buying or financing a car outright means contending with depreciation. Some new cars typically depreciate by more than 20% in the first year[1]. This means that if you were to sell it within the first year, you might be upside down on the finance, which is owing more to the lender than what the car is worth.
- Higher monthly installments: The monthly payments made toward a finance agreement go toward paying off the car. The buyer will own the car at the end of the term. Though not always the case, depending on credit score and down payment, this is typically at a higher installment than with a lease agreement.
What Does It Mean To Lease A Car?
During a car lease, you as the lessee (the person taking the lease) pay a monthly payment to use the car. It's much like a rental contract, where the car is returned at the end of the term. These terms typically run for 24 to 48 months[2]. Make sure you understand what a car lease is, and consider the pros and cons of leasing a car before deciding to go this route.
Pros Of Leasing A Car
There are instances where leasing a car might be a better fit. Some of the benefits of leasing a car include:
- Lower monthly installments and smaller down payments: Lease payments are typically lower than financing payments for the same make and model, but they function more like rental fees rather than contributing toward ownership. Additionally, lease agreements usually require a smaller down payment, and in some cases, no down payment at all.[3]
- New car every few years: Leasing lets you drive a new car every few years, so you can always have the latest safety features, tech, and warranty coverage. It also gives you flexibility. If the car is not a great fit long term, you can walk away when the lease ends. If you like it, you may have the option to buy it.
- Flexibility: When a leased car turns out to be problematic, the lessee can return it to the lessor. This might not be as simple when a vehicle is financed.
- Fixed price: The lease buyout price is determined in advance. If the car's value doesn't depreciate quite as much as predicted by the lessor, the lessee might end up being in a better equitable position at the end of the term. If so, they can buy out the lease and trade the car in for a higher value.
Cons Of Leasing A Car
A car lease doesn't work for everyone. Here are some of the possible drawbacks:
- Mileage costs: A lease agreement often restricts you to 10,000 or 15,000 miles per year. Those who exceed these restrictions typically pay an excess mileage charge of 10 to 25 cents per mile.[4] You may be able to structure a lease with higher mileage, but that will typically increase your monthly payment.
- Wear and tear: It's important to return the car to the agency in good condition. If not, you can face charges for excessive wear and tear. The types of driving events that may add excessive wear and tear, and additional mileage, include family driving trips, long commutes, or using the vehicle for ride share or part-time delivery jobs.
- Cancellation costs: If the lessee needs to end the lease before the term ends, they may expect to pay penalty costs, called a termination fee. This is because the lessee covers the costs of the market value decline, which happens more rapidly at the beginning of a lease[5]. However, if the lessee just buys out the lease, there's usually no termination cost. See the example below of how cancellation costs might be calculated.
If you reach the end of your lease and want to keep your car, a lease buyout could be worth considering. This allows you to purchase the vehicle at a predetermined price, which might be a good deal if its market value is higher than expected. Before deciding, compare your long-term costs to determine if leasing or financing makes more sense for you.
Comparing Financing and Leasing
Both buying and leasing have advantages and drawbacks. The right choice depends on your budget, driving habits, and long-term plans. If you want to eventually own your vehicle and drive as much as you like, financing might be a better fit. If you prefer lower monthly payments and a new vehicle every few years, leasing could be the way to go.
See Chart:
| Feature | Financing a Car | Leasing a Car |
|---|---|---|
| Ownership | You own the car once it's paid off. | You return the car at the end of the lease unless you buy it. |
| Monthly Costs | Typically higher monthly payments but build equity. | Typically lower monthly payments with no ownership. |
| Mileage Limits | Unlimited miles. | Limited to 12,000-15,000 miles per year, with feees for excess mileage. |
| Customization | Can modify or upgrade as desired. | Cannot make permanent modifications. |
| Wear & Tear Costs | You handle repairs as needed. | Excess wear may lead to penalties at lease-end. |
| Long-Term Cost | More cost-effective if you keep it for years. | May cost more over time if you continually lease. |
| Flexibility | Can sell or trade in anytime. | Early termination can be expensive. |
| Warranty Coverage | Varies; may need extended warranty after a few years. | Usually covered under warranty for the lease period. |
| Down Payment | Often requires a larger down payment. | Typically requires less upfront, and sometimes none. |
If you plan to keep a car for many years, buying often makes better financial sense in the long run. However, leasing can be attractive if you value new technology, lower monthly costs, and frequent vehicle upgrades.
Cancellation Cost Example
Ending a lease early usually triggers a termination fee. This cost helps cover the remaining payments and the drop in the vehicle's value. If you’re thinking about canceling a lease before it ends, it’s important to know what you could owe.
Here’s a simplified example:
Jenny leases a car valued at $45,000 with a residual value of $20,000 and a monthly payment of about $680. If she ends the lease with 12 months left and the car’s current market value is $26,000, her estimated termination cost would be around $2,160.
This fee shows up when you return the car early. If you plan to keep the lease for its full term, you won’t face this charge. It is not especially common, but it can happen, especially if your needs change, you relocate, or the car turns out to be a poor fit. If there's a chance you might want out early, consider flexible options like a lease with a buyout path or a shorter term.
Final Thoughts
Is it better to lease or buy a car? Whether you decide to buy or lease a car depends entirely on personal needs, financial position and how long the car will be used. Be sure to explore both options and make the decision that best meets your needs.
Learn more about vehicle finance options and calculate your monthly payments here.
