The lure of lower out-of-pocket costs for a nicer car is hard to ignore, but is a lease the smartest financial choice? Leases are essentially long-term rentals, typically three to four years. At the end of the lease, you have the option of returning the car or purchasing it from the dealer at the residual value which is the predetermined value of the car at the end of the lease.
The biggest advantages to leasing a vehicle are the lower upfront costs and monthly payment. Many leases require a much smaller down payment than a typical purchase and there are no sales tax charges. For those who lease instead of purchase, there’s the thrill of a new car every few years and that means your maintenance costs will also be lower as new cars will have a warranty. For business owners, leasing vehicles can also offer tax advantages.
When leasing a car, you want to pay close attention to the residual value. You want to lease a car that has a low depreciation rate. A low residual value means that you are absorbing a high depreciation during the term of your lease.
You also want to look at mileage restrictions. Some are capped at 12,000 or 15,000 miles per year. If you drive more than that, you could be hit with a larger than expected bill at the end of the lease.
Lease agreements may also contain ‘excessive wear and tear’ clauses. Be sure to read your contract carefully so you aren’t surprised by additional charges when returning the car at the end of the lease.
When you purchase a car, you are usually required to make some type of down payment. Depending on your credit, some lenders may lend up to 100% of the MSRP of the car. You’ll also need to pay the sales tax on the vehicle. This can be several hundred dollars upfront. Also, because your payment covers the purchase of the car instead of only the depreciation, the payment will be higher. Depending on the type of car, the amount of your down payment and the term, the value of the car could fall below your loan balance, making you ‘upside down’ in the loan. This means that should you total your car, the amount you receive from the insurance company may not cover your loan balance. This would not happen with a lease.
On the other hand, because you are purchasing the car, you don’t have the restrictions of a lease. You can drive as many miles as you wish and there’s no such thing as ‘excessive wear and tear.’ Once you pay off your loan, your monthly payments cease and the car is yours. You have the option of selling it to purchase a new car or driving it payment-free as long as you want. Don’t forget that as the mileage builds up on a car, so do the maintenance expenses so you’ll need to determine if the additional maintenance is worth not having a monthly payment.
Whether to lease or purchase depends on your objectives – lower upfront costs, a new car every few years and lower maintenance costs or fewer driving restrictions and not having a car payment once the loan is paid off.
If you aren’t sure which is the best option for you, our loan specialists can help! Call us at 336.774.3400 to get started!
Pareto, C. Investopedia. New Wheels: Lease or Buy (12.12.2018)