When it comes to acquiring a vehicle, one of the most significant decisions you’ll face is whether to lease or finance the car. Both options come with their unique benefits and considerations. Understanding these can help you align your choice with your financial goals and personal preferences.

Car Buying Options: Leasing vs. Financing
In early 2024, the average price of a new car was approximately $47,401, while a used car averaged around $25,540, according to Kelley Blue Book. If you don’t have the full amount saved, leasing or financing are viable options.

Leasing a Car
Leasing is akin to long-term renting. You enter a lease agreement specifying the duration, monthly payments, and mileage limits. Here’s what you need to know:

• Capitalized Cost: This is the agreed-upon value of the car plus any additional costs like taxes and registration. It’s crucial to understand this as it impacts your monthly payments.
• Lease Term: Typically lasting three to four years, the lease term is the period during which you’ll use the vehicle. There are options for both shorter and longer terms.
• Residual Value: This is the car’s estimated value at the end of the lease. For instance, a car worth $40,000 with a 60% residual value would be valued at $24,000 at lease end. This percentage generally isn’t negotiable.
• Money Factor: This is the interest rate for your lease, expressed as a decimal. To convert it to an annual percentage rate, multiply the money factor by 2,400. For example, a money factor of 0.0020 translates to an interest rate of 4.8%.

At the end of the lease, you typically have the option to return the vehicle, purchase it, or lease another car.

Financing a Car

When financing, you take out a loan to purchase the vehicle. Here are the key components:

• Principal: This is the total amount borrowed for the vehicle, often reduced by a down payment or trade-in.
• Interest Rate: The cost of borrowing money annually. As of the second quarter of 2024, the average rate for a 60-month new vehicle loan was 8.20%, according to the Federal Reserve. Your credit score significantly affects this rate.
• Total Cost: This includes the principal, interest, taxes, and fees.
• Loan Term: Typically ranges from 62 to 74 months. Shorter terms mean higher monthly payments but less interest over the loan’s life.

You can secure a car loan through banks, credit unions, online lenders, or dealerships. A shorter loan term will result in higher monthly payments but will save you money on interest.

When Leasing Makes Sense

Leasing is ideal if:

• You Prefer Lower Monthly Payments: Leasing often offers lower payments compared to financing. For instance, in late 2023, the average lease payment was $587 compared to $703 for new car loans.
• You Enjoy Driving a New Car: Leasing is suitable for those who like the idea of driving a new vehicle every few years and don’t mind not building equity.
• You Don’t Drive Much: Leasing comes with mileage limits, typically 12,000 miles per year. Exceeding this can incur significant fees. If you have a long commute or frequently take road trips, leasing might not be the best option.
• You Want to Avoid Major Repairs: Since leases cover newer cars, you’re less likely to face major repair issues.

When Financing is the Better Choice

• Consider financing if: You Plan to Keep the Vehicle Long-Term: Financing is usually better if you intend to keep your car for several years after the loan is paid off. Once the loan is completed, you can enjoy payment-free years with the vehicle.
• You’re Not Concerned with Driving a New Car: If having the latest model isn’t a priority, financing and keeping your car long-term can be more economical.
• You Put Heavy Wear and Tear on Your Car: Financing is preferable if you expect to exceed mileage limits or put significant wear on your vehicle.

Pros and Cons of Leasing vs. Buying

Leasing Pros:

• Lower Monthly Payments: Generally less expensive monthly payments than financing.
• Easier to Upgrade: Convenient to switch to a new car every few years.
• Minimal Down Payment: Often requires little to no down payment.
• Fewer Maintenance Issues: Leased cars are usually under warranty during the lease term.

Leasing Cons:

• Continuous Payments: You will always have a car payment if you continue leasing.
• No Equity: Lease payments don’t build ownership.
• Mileage Limits: Exceeding mileage limits can be costly.
• Additional Fees: Includes acquisition and disposition fees, plus potential early termination fees.

Buying Pros:

• Build Equity: Each payment increases your ownership stake.
• No Mileage Restrictions: Freedom to drive as much as you like.
• Customization: Ability to modify your car as desired.
• Flexibility to Sell: You can sell or trade in your vehicle at any time.

Buying Cons:

• Higher Payments: Monthly payments are typically higher than lease payments.
• Depreciation: The car’s value drops, which may lead to negative equity.

Maintenance Costs: After the warranty expires, maintenance costs can rise.

Selling or Trading In: Requires effort to sell or negotiate trade-ins.

Insurance Considerations
Whether leasing or financing, you must meet state insurance requirements, which often include liability coverage. For leased or financed cars, comprehensive and collision coverage is usually required by the lender or leasing company. Gap insurance can be beneficial if you owe more on the lease or loan than the car’s current value.

Conclusion
Choosing between leasing and financing a car depends on your financial goals and personal preferences. Leasing offers lower payments and the ability to drive a new car frequently, while financing allows for long-term ownership and potential cost savings. Evaluate your driving habits, budget, and how long you plan to keep the car to make the best decision for your situation.