Difference Between Lease and Finance
If you're new to the car buying game, the major difference between leasing a car and financing a car is that leasing is paying for only a portion of the car, whereas financing a car is paying for all of the car.
In the case of leasing, you are paying for the drop in the value of the car (depreciation) between the start of the lease and the end of the lease. This means you won't ever build up any equity in the vehicle (equity is the difference between what you could sell the car for and what you owe on the car).
On the other hand, if you take a loan out to purchase a car, you will end paying for the drop in value from the time you purchase the car to the time you sell or scrap the vehicle. In this case, you do have the opportunity to build up equity if you are paying down the car loan faster than the car is depreciating.
Which is Better, Buying or Leasing?
If you're asking "should I lease or buy a car?", the answer depends on your financial situation and on how you intend to use and care for the vehicle.
Buying May Be The Better Choice If ...
You expect to drive more than 15,000 miles per year. This is because a lease usually limits the number of miles you can drive to 10,000 to 15,000 miles per year. If you exceed the mileage limit, you will end up paying a fee (fine) for the excess miles.
You expect to own the car for a long period of time (6-10 years or more). This is because you will eventually pay the car off and no longer have any monthly payments. These monthly payments you no longer have to make can then be used to save up a sizeable down payment for your next auto purchase.
You're concerned about the likelihood of minor damage occurring to the vehicle. If you purchase the car and it gets minor dings, dents, and paint scuffs, you can choose to ignore them. Not so with leasing, as the leasing company will charge you for that damage at the end of the lease.
You want to customize to the vehicle. Customization is not permitted in the case of a lease.
Leasing May Be The Better Choice If ...
You expect to drive the vehicle less than 10,000 miles per year, you are not concerned with the likelihood of minor damage, and you have no desire to customize the vehicle.
You want a lower monthly payment. Because you're only paying for a portion of the car instead of all of it, car lease payments are typically lower than car loan payments.
You want to drive the latest cars with the latest technologies. Because the same lease payment will afford you more car than the same loan payment, leasing will likely afford you to drive higher end or higher tech cars (electric, etc.).
My Personal Preference
Based on my financial situation, auto needs, and a big list of other things I'd rather spend my money on than car depreciation, I will always choose to buy over leasing.
I'm still driving a Chevy Avalanche I purchased new in October of 2001, and have been able to deposit my former, monthly truck payment ($585) into a "Vehicle Purchase, Maintenance, and Repair" savings account since 2005 ($98,280 and counting!).
Leasing Should Always Cost More Than Buying a Car
The reason leasing a car should always be the more expensive alternative, is because if you own the purchased vehicle long enough, you open the door to two money-saving opportunities.
First money-saving opportunity: The longer you own a purchased vehicle, the lower will be the average annual depreciation rate. So if you lease (or buy) a new vehicle every two years (typical lease term), the average annual depreciation expense may run as high as 20% of the purchase price. On the other hand, if you purchase a new vehicle every ten years, the average annual depreciation rate may be less than 10% of the purchase price.
The following chart shows how the average annual depreciation expense percentage drops the longer you own a purchased vehicle (be sure to experiment with your entries into the car buy versus lease calculator to see what difference the years of ownership can make).
| $20,000 Automobile at 20% Annual Depreciation | ||||
|---|---|---|---|---|
| Own
YrsOwn YrsYears OwnedYears Owned | End of Year
Market ValueEnd of Year Market ValueEnd of Year Market ValueEnd of Year Market Value | DeprecDeprecDeprecDepreciation | Accum
DeprecAccum DeprecAccum DeprecCumulative Depreciation | Avg
Ann DeprecAvg Ann DeprecAverage Annual DeprecAverage Annual Depreciation |
| 1 | $16,000 | $4,000 | $4,000 | 20.00% |
| 2 | $12,800 | $3,200 | $7,200 | 18.00% |
| 3 | $10,240 | $2,560 | $9,760 | 16.27% |
| 4 | $8,192 | $2,048 | $11,808 | 14.76% |
| 5 | $6,554 | $1,638 | $13,446 | 13.45% |
| 6 | $5,243 | $1,311 | $14,757 | 12.30% |
| 7 | $4,194 | $1,049 | $15,806 | 11.29% |
| 8 | $3,355 | $839 | $16,645 | 10.40% |
| 9 | $2,684 | $671 | $17,316 | 9.62% |
| 10 | $2,147 | $537 | $17,853 | 8.93% |
Second money-saving opportunity: If you own a purchased vehicle long enough eventually the auto loan will be paid off -- meaning that for as long as you continue to own the vehicle you will not have a monthly car payment.
However, if you lease a new vehicle at the end of every lease term you will always have a monthly lease payment.
And take a guess as to what you can do with that monthly car payment that you will no longer have to pay out?
That's right; you can be depositing that amount to your savings account each month. In turn, this means that if you keep the vehicle for twice as long as the loan term, you should be able to pay cash for your next vehicle -- thereby avoiding future interest and lease fees altogether.
And what can you do with the future lease or interest fees you will be saving?
Yes, you can either invest in your high interest debt or invest in traditional investments -- either of which will serve to increase how much car you can afford.
Cash Versus Financing or Leasing
When it comes to determining how much car you can afford, cash is king. Why?
Because, since you've already earned the cash you are spending, you can assign the proper value to that denomination of cash. Whereas if you borrow the money to purchase a vehicle, or borrow the value of the vehicle (lease), you have no idea what you will have to do to earn the money needed to repay the value you borrowed -- meaning you won't be able to assign a proper future value to it.
What do I mean by "assigning the proper value" to cash or future value?
Think of it this way. Would $100 a month be more valuable to you if you were earning minimum wage than if you were earning $100 per hour?
Or, would $100 a month mean more to you if you were digging trenches by hand in bitterly cold weather instead of performing a work you loved in a comfortable environment?
Or, does $100 mean as much to Bill Gates (billionaire) as it means to you?
You see, it's not the denomination of cash that determines its ultimate value, it's what you have to do to earn it.
And since you don't have a crystal ball, you have no idea of what you will have to do to earn future denominations of money. Therefore it is absolutely impossible to make wise financial decisions with money you haven't yet earned.
What if you lose your job and find yourself making half as much as you used to? Will you be willing to work twice as many hours to make the monthly loan or lease payments?
What if you discover a dream job that perfectly suits your talents, abilities, and genuine interests, but it would require you to take a cut in pay? Would you still consider the auto purchase or auto lease to have been a wise decision if you can't afford to take the dream job due to these high payment obligations?
You see, paying cash for a car is the only way you can make a car buying decision that will serve your best interests now and in the future.
Could You Afford Your Last Car?
Well, if you don't have the cash needed to purchase a car now, then it's likely you couldn't "afford" the last vehicle you purchased.
The only way to determine what price you can afford to pay for a vehicle is to determine what price range will allow you to set aside the depreciation expense each month. This is an amount that is over, and above any lease or loan payment, being saved to pay cash for your next vehicle -- cash that you can assign a proper value to.
So if you can't afford to pay cash for a car, you can't afford the car. Yes, you may need the car even though you can't afford it. But this only means you will need to work twice as hard to save up enough cash so that you can make a wise financial decision when it comes time to buy your next vehicle.