When shopping for a new car, there are multiple factors you need to consider. Determining the right financing option is one of them.
Leasing a car and getting an auto loan both have advantages and disadvantages. Considering your circumstances and needs will help you make an informed financial decision. It’s also important to understand how leasing a car differs from getting a loan, what fees are involved and how to get auto insurance.
Leasing vs. Buying: Learn the Major Differences
Buying means to purchase a car and acquire ownership by paying in lump sum or installments. On the other hand, leasing refers to an agreement that allows a person to use the lessor’s vehicle for a certain period in exchange for periodic payments.
Determining whether you should lease or buy a car requires understanding your options. Take some time to research and learn the differences between the two.
Below are some of the major differences between leasing and owning a car that you need to:
Factor | Leasing a Car | Buying a Car |
|---|---|---|
Upfront costs | This is the amount you need | This is the cost of owning the |
Monthly payments | Payments for car leases are | Some buyers choose to take |
Maintenance | Typically, leased vehicles are | Buying a car makes you the |
Wear and tear | The lessee ensures that the | Wear and tear won’t have |
Use or mileage | Car leases have mileage | There’s no mileage limit since |
Customization | Lessees can’t customize or | Owning the car allows you to |
Ownership | The lessee doesn’t own the | The buyer will own the |
End of the term | The lessee may choose to | At the end of the auto loan |
Transfer | The lessee doesn’t own the | The buyer is the car's owner, |
Parties | There are two parties | There are two parties |
Is Leasing a Car a Good Idea?
Leasing a car simply means renting a vehicle from a dealership for a certain period and mileage limit. You gain the right to drive the vehicle in exchange for monthly lease payments. Although this option can be a good idea, it’s not always ideal.
Your circumstances will determine whether you should lease a car or not. Make sure you consider the actual cost of leasing a car, its pros and cons, when it can be the best option and how to get insurance.
True Costs of Leasing a Car
Monthly lease payments cost an average of $540 in the second quarter of 2022, according to Experian . Actual costs may vary depending on the vehicle model, term and mileage limit. There are also other fees the lessee should pay, such as acquisition fees, initial payment and security deposit.
The table below enumerates the most common fees and what they cover:
Type of Fee | What It Pays For |
|---|---|
Acquisition fee | The acquisition fee, also known as administrative, origination or bank fee, is the amount you need to pay the leasing company to establish the lease agreement. It typically ranges from a few hundred to a thousand dollars. Depending on the agreement, this can be paid upfront with the down payment or added to the monthly payments. |
First payment | A payment for the first month is typically required before the car is released to the lessee. The amount depends on the vehicle, your location and the dealer. |
Security deposit | Putting down a security deposit is typically necessary. This usually equals a month’s payment and will cover any damages that may occur to the vehicle. |
Disposition fee | At the end of the lease, the lessee has the option to purchase or return the car. You’ll be charged a disposition fee if you choose to return it. It’s usually a few hundred dollars. |
Sales tax | Vehicle leases are typically charged with a sales tax. The cost depends on state regulations. |
Documentation fee | Documentation fees can be $150–$300. This fee is charged for the creation and processing of the car lease. |
Upfront costs | A down payment is the amount you pay to get the right to use the vehicle. This is similar but typically cheaper than the down payment required for a car loan. |
Wear and tear charges | The security deposit doesn’t always cover the wear and tear to the leased vehicle. The lessor may charge penalties for excessive damage. |
Excess mileage | Going over the mileage limit set per the lease agreement may result in an excessive mileage fee. It typically costs a few cents per mile. |
Advantages and Disadvantages
Weighing the pros and cons of leasing a car is an important step you need to take to make sure this is the best option for you. For instance, leasing may come with lower monthly costs. However, there are more restrictions. Consider your needs and determine if leasing benefits outweigh the drawbacks.
- Lower monthly costs: Instead of paying for the total cost of the vehicle, you’ll only pay for the right to use the car.
- Worry-free maintenance: You’re likely to be responsible for routine maintenance only. Additionally, you may enjoy warranty protection benefits.
- Potential perks: Sales taxes for car leases tend to be lower. If you’re using the vehicle for business, you may also be entitled to possible tax deductions. You may qualify for free oil charges.
- Easy upgrade: At the end of the lease term, you may be given the option to buy the vehicle or return it. You may also choose to lease a better vehicle.
- Additional fees: You may be charged with extra fees like documentation, excessive mileage, excessive wear and tear, disposition and security deposit.
- No ownership: You don’t own the car you’re driving despite the monthly payments. That said, you may have a buyout option at the end of the lease term.
- Lack of control: Car leases have mileage limits. You’re likely to be charged with a fee if you go over tap. You also can’t make changes or customization to the vehicle because you don’t own it.
When Does It Make Sense to Lease a Car?
Leasing may not be the first choice of many when thinking of getting a car. But there are certain instances when it makes the most sense. For example, ex-pats, older adults, individuals with a fixed monthly income and those who tend to change cars quickly may find leasing beneficial.
If you find yourself in any of the following situations, you may want to consider leasing.
You need a vehicle for short-term use
The main point of a car lease is to have a vehicle you can use without the commitment and responsibility of being a car owner. Leasing is the better option if you plan on using the vehicle for a few years, whether for business or personal purposes.
You can’t cover high monthly payments
Buying a car requires you to cover the vehicle’s full price. Even if you take out an auto loan, monthly payments can be high. If you live on a fixed monthly income and find it difficult to shoulder high expenses, consider leasing a car. A report by Experian shows that you can save an average of $127 monthly by choosing to lease over getting an auto loan.
You’re an older adult
Seniors living on a fixed income and looking to drive for only a few years may find leasing a good idea. Leasing a car also allows them to take advantage of the latest safety systems and technology. Additionally, leasing requires less maintenance.
You’re an expatriate
Expatriates coming to the U.S. who want to enjoy driving around without a long-term commitment may find leasing cost-effective. You can keep the car for as long as you need and easily return it after the lease expires or when you no longer need it.
You like changing cars quickly
People who tend to keep a vehicle for around two–five years only may incur huge expenses due to constant purchases or trading up. If this is the case for you, consider leasing a car. After the lease term, you can switch to a newer model if you want.
How to Insure Your Leased Vehicles
Auto insurance provides financial protection against possible considerable expenses in the event of an accident. Most states require drivers to meet a minimum coverage requirement. However, some individuals who plan on leasing a vehicle may find car insurance a bit confusing.
The best car insurance will depend on specific factors, such as location, age, gender, credit score and driving history. Requirements for getting a policy may also vary depending on the state and leasing company.
Below are some common insurance requirements for leased cars.
Insurance Requirements for a Leased Car
Type of Insurance | What It Covers |
|---|---|
Bodily injury liability insurance | This pays for the medical expenses another party may incur if the policyholder is at fault in the accident. |
Property damage liability insurance | This coverage pays for damages the policyholder may cause to another party’s property. |
Uninsured and underinsured motorist insurance | Getting an uninsured and underinsured insurance policy can protect you in the event of getting in an accident where the at-fault driver is uninsured or doesn’t have enough coverage. Some states may require drivers to carry this insurance. |
Personal injury protection | Personal injury protection pays for medical expenses that you or your passengers may incur due to injuries sustained in a car accident. Some states require PIP coverage. |
Collision coverage | Collision insurance pays for any damage to the leased car due to a collision with another vehicle or an object. |
Comprehensive insurance | Comprehensive coverage pays for damages to the leased car caused by non-collision incidents, such as falling objects, natural disasters, vandalism and theft. |
What You Need to Do When Your Lease Car Ends
At the end of the lease term, the lessee is given four options.
You can purchase the vehicle and finance its remaining value.
If you no longer need a car, you may simply return it to the dealer.
If you want to continue using the vehicle, you can extend your lease for a limited time.
If you want to lease the current vehicle, you can opt to re-lease. This is often a cheaper option than leasing a new car.
If you decide to end the lease early, whether due to a job loss, change in income or moving to another location, you may be subject to early termination rules per your lease agreement. Here are some of the possible options for you:
Transfer the remainder of the lease contract to another party
Pay off the amount stated by the lessor and sell the vehicle
Trade the leased car for another vehicle from a dealership
Keep in mind that early termination of a car lease may come with a fee. Make sure you discuss this with your lessor.
Is Buying a Car a Good Idea for You?
The main benefit of buying a car is ownership. Unlike car leases, the buyer gains full vehicle ownership after completing the payments. For some, this means paying a huge lump sum upfront. Others may opt for a loan and installment plan. No matter the financing, finding the right price and car is crucial.
Additionally, it’s essential to consider all fees involved, the pros and cons, and when it makes the most sense to purchase a vehicle.
The True Cost of Buying a Car
Being a car owner comes with various expenses. Aside from the price of purchasing the vehicle, other payments are involved.
The average cost of car ownership is $9,282 per year or around $773.50 per month. Those who choose to finance their purchase through an auto loan may need to pay an extra $667 per month, according to Experian.
Below is a breakdown of the common fees car buyers need to take note of.
Type of Fee | What It Pays For |
|---|---|
Title and registration fee | States charge a couple of hundred dollars for title and registration fees. In most cases, dealers have an agreement with state departments to give titles and registration for the cars they sell. Title and registration fees don’t go to dealers but the state. |
Sales tax | Typically, states charge a sales tax for vehicle purchases. The cost may vary per state. Cities and counties may also charge sales taxes on top of the state tax. |
Destination fee | The destination fee is the amount buyers need to pay to transfer the vehicle from the factory to the dealer. The automaker typically sets the amount. |
Documentation fee | This refers to the cost a dealer charges for the processing of paperwork, such as the car title and registration. The cost may vary per dealer and location but typically costs a few hundred dollars. Some states impose a limit on how much dealers can charge. |
Inspection and emission fee | Many states require vehicles to pass safety and emission inspection before they can be sold. Some dealerships pass this cost on to the buyer. Clarify this with your dealer to prevent unexpected expenses. |
Advantages and Disadvantages
Similar to leasing, buying a car comes with advantages and disadvantages. Depending on your needs as a driver, the benefits may outweigh the drawbacks. The table below enumerates some of the major pros and cons of buying a car to help you get started.
- No restrictions and full ownership: After completing the payments, you gain full ownership of the car. You can customize and modify the vehicle.
- No extra fees: You don’t have to worry about additional fees, such as excessive wear and tear or mileage.
- No mileage limits: You don’t have to be wary of your car mileage. There are no mileage limits you need to follow or penalties to worry about.
- Depreciation: The value of a car starts to depreciate as soon as you drive it off the lot. That means its trade-in or selling value is lower than the amount you paid.
- Driving costs: Maintaining a car can be expensive. Aside from the purchase price, you need to pay for maintenance and repairs. You’ll also spend money on fuel and auto insurance.
- Higher payments: Buying a car is more expensive than leasing. That’s because you’re paying for the entire cost of the car. You may be charged with interest if you take out a loan.
When Does It Make Sense to Buy a Car?
Evaluating your financial situation and specific needs is the best way to determine if buying a car makes sense. A vehicle can be an expensive purchase. It’s important to ensure that it’s the best possible solution for you.
Buying a car may be better than leasing if you see yourself in the following situations.
You plan on using it for a long time
Leasing offers short-term access to a vehicle. Buying may be right for you if you plan on keeping the car for around five or more years.
You have special needs
If you or a loved one is a person with a disability, you may need a car with safety features. Depending on your circumstances, vehicle modification may even be necessary. In such a case, it’s better to purchase a car.
You drive a lot
If you plan on using the car often, you may want to consider buying it. That’s because car leases typically come with mileage restrictions.
You’re financially independent
If your financial situation allows you to spend a small fortune on a new car or if the monthly loan payments are affordable, then buying can be a good option.
Financing Your Vehicle Using Auto Loans
Before choosing a vehicle, buyers should determine the best way to finance their purchase. Some individuals pay the full price of the car in a lump sum. This is a good idea if you can afford to pay cash upfront. Otherwise, you may need to take out an auto loan.
Here’s a simple guide to help you navigate auto loans.
Check your credit score
One of the most important factors lenders consider when evaluating loan applications is the credit score. Understanding the importance of your credit score can help you find the best lender and loan offer. Your credit score reflects your creditworthiness and ability to repay the loan. A higher score can help you access more loan offers. A lower score may limit your choices.
Shop around
Don’t settle for the first lender you find. Lenders have different loan offers, requirements and terms. Some may also offer promotional rates or discounts. Generally, getting quotes from at least three lenders can help determine how much your monthly payments will cost.
Learn the lending language
There are certain terms you need to familiarize yourself with if you plan on taking out an auto loan. Here are some of them:
- Car loan: Also called car financing, a car loan is the contract between the lender and borrower.
- Interest: Lenders charge interest, expressed in rates, to the money borrowed. This varies per lender and is specified in the loan agreement.
- Loan Term: This is the length of the loan. It’s typically expressed in months. During the loan term, the borrower makes monthly payments to the lender to repay the loan amount plus its interest.
- Principal: This is the loan balance. At the start of the term, the principal is equal to the total loan amount. As the borrower makes monthly payments, the principal declines.
- Down payment: This is the amount the borrower plans to pay toward the car purchase. Lenders consider this when calculating the loan amount.
- Monthly payment: This is the agreed-upon amount the borrower needs to pay throughout the loan term. Each month, the borrower pays a certain percentage of the principal plus interest.
Apply for an auto loan
Once you’re 100% sure that an auto loan is the right financing option, you may proceed with the application. Choose the lender that offers the best deal.
You may submit multiple applications. However, doing it in a short period of time isn’t recommended as these applications may impact your credit score.
Examine the offer
If your loan application gets approved, the lender will send you the loan agreement. Review this document. Read the fine print. Make sure you understand all details to avoid misunderstandings.
Negotiate and finalize the deal
Clarify all terms and conditions with the lender. Negotiate if necessary. Once you find the deal acceptable, you can sign the loan agreement. Depending on the lender, the loan amount may be released within a few days.
Tips on Finding the Best Auto Loan Deals
Choosing the right auto loan company can be challenging, especially for first-time borrowers. Doing your research, shopping around and knowing what factors lenders consider can help you find the best deal.
- Compare rates and costs
The best auto loan deal may vary depending on your needs and circumstances. That’s why shopping around is necessary. Compare loan offers from at least three lenders. Check the loan features, especially the annual percentage rate, monthly payment and the length of the loan.
- Research loan length and loan offers
Researching the lenders available can help you decide where to submit a loan application. Review previous and current clients to see if a lender has reasonable rates and good customer service.
- Limit your applications
Don’t submit applications to multiple lenders at once. Lenders tend to conduct a hard credit inquiry when evaluating loan applications. This credit check is recorded in your credit report and may affect your credit score. Some lenders have pre-qualification tools that borrowers can use to check if they qualify for a car loan. These tools may also allow borrowers to check potential loan amounts, payments and interest rates.
- Improve your credit
Try to improve your credit score first before applying for a loan. Generally, individuals with good to excellent credit scores have a higher chance of getting approved for a loan. They may also have better loan options.
3 Factors to Consider When Choosing Between a Loan vs. a Lease
Choosing between an auto loan or a car lease can be a challenging experience. Knowing what factors to consider can help you determine the more appropriate option. Comparing costs is a must, but understanding your needs and financial situation is also crucial.
Below are some tips that may help you decide between the two options.
Consider your finances
Determine how much you can spend on monthly payments. This is one of the most critical steps you should take. You wouldn’t want to enter a commitment without proper consideration. If you’re living on a fixed income and looking for the cheapest option, leasing may be right.
Calculate the costs
The actual cost of leasing and buying goes beyond the initial costs. For instance, the upfront costs for a new car model may be cheap, but there are other expenses you need to take care of, like maintenance, tax and monthly payments.
Evaluate your needs
Another important factor to consider is how you plan on using the car. Leasing is more cost-effective if you only need it for a few years. But if you plan on using the car often, you may have to consider buying. That’s because car leases have mileage restrictions.
Leasing Lingo
There are various terms used in the car leasing industry. Below are some terms and definitions to help you better understand leasing.
Terms | Definition |
|---|---|
Acquisition fee | A fee charged to the lessee to start a lease, which generally begins in the $400 to $500 range. |
Capitalization cost | The final negotiated price of the vehicle to be leased. |
Closed-end lease | In this lease, the residual value (value of the vehicle at the end of the lease) is estimated and agreed upon in advance by you and the dealer. At the end of the lease, you won't have to pay extra (or will receive a refund) if the car turns out to be worth less or more than the agreed upon price. |
Depreciation | The value that a vehicle loses over time. |
Disposition fee | A fee charged when you return your vehicle at the end of the lease, typically $350, that covers the dealership's cost to dispose of the vehicle. |
Early termination fee | A fee charged when you end the lease before the agreed upon term is up. According to Consumer Reports, this fee can be almost as expensive as finishing out the contract. |
Mileage allowance | A maximum limit you may drive the car each year without having to pay an extra fee. A 12,000 mileage allowance per year is typical on most leases, but this can be negotiated. |
Mileage fee | A fee that you have to pay if your drive over the limit specified on a lease. This is often around $0.25 per mile. |
Money factor | Known as the lease factor, it is the financing fee you are charged. It is expressed not as a percentage rate, but a multiplier. To determine the money factor, divide the interest rate by 2,400. For example, a 6.96 percent interest rate is equivalent to a money factor of 0.0029. |
Open-end lease | In this lease agreement, you agree to take financial risk for the value of the vehicle when the lease expires. If the vehicle is worth less than expected, then you have to pay the difference at the end of the lease. If it is worth more, the dealer pays you the difference. |
Payoff amount | The amount of money you have to pay at the end of the lease if you decide to purchase the vehicle. |
Purchase option price | The total price that you would have to pay to purchase a leased car. This price is stated in the lease agreement. |
Residual value | The leasing company's estimate of what the car will be worth at the end of the lease. |
Security deposit | A deposit, typically equaling one month's payment, you pay before taking over a leased vehicle. You'll get this money back if you return the car in relatively good shape. |
Term | The length of the lease agreement. Most leases are for either 24, 36, 48 or 60 months. |
Expert Insight on Buying a Car
There are various factors to consider when deciding whether to take out a car loan or a lease. MoneyGeek asked some industry experts to provide insights to help you make an informed decision.
- What’s the most important factor(s) consumers should consider when deciding whether to lease a car or get a loan?
- What money-saving tips can you share with consumers considering buying a car?
- What resources/tools can you share to help consumers decide how to finance a car purchase?
- What are the best alternatives to leasing a car or taking out a car loan?
Accredited Financial Counselor and Director of Education at Your Money Line
Auto Broker at HM Brown Automotive
Director of Marketing and Sales at Gunther Motor Company
Resources for Buying a Car
The right resources can help you better understand your options and make an informed decision about owning a car. You can find the following relevant resources to help you determine the best option for you, your budget and your circumstances.
Car Ownership
- Consumer Reports: Get tips on effectively negotiating the cost of a car.
- Edmunds TMV: Compare the true market value of different vehicles based on year, make and model.
- Federal Trade Commission: Learn from consumer guides on buying a new car and purchasing a used car. Find out more about financing a car purchase using the commission’s Buckle Up: Navigating Auto Sales and Financing report.
- Kelley Blue Book: Check a car’s value, find vehicles for sale or get free dealer price quotes.
- USA.gov: Find out how to get a driver’s license and register a car. Get tips on how to file complaints about a car, car rentals and auto loans.
- Car buying and comparison sites: Shop around and compare car costs by visiting car buying sites like TrueCar and CarMax.
Auto Insurance
- Coalition Against Insurance Fraud: Get updates on different auto scams and insurance fraud.
- Insurance Information Institute: Learn about different types of insurance. Access useful data and insights on the auto insurance industry.
- National Association of Insurance Commissioners: Get basic information about auto insurance, the different coverages, your responsibilities and how to file a claim.
- National Insurance Crime Bureau: Be informed about auto insurance fraud and theft. Get tips to prevent scams when buying a vehicle.
- State Department of Insurance: Visit your state’s department of insurance website and find out the minimum auto insurance coverage requirements. Some states even include a list of companies offering auto insurance, such as Massachusetts and California.
About Nathan Paulus
sources
- Bureau of Transportation Statistics. "New and Used Passenger Car and Light Truck Sales and Leases." Accessed September 23, 2022.
- Experian. "Leasing Continues to Decline in Q2 2022 Amid Inventory Shortages." Accessed September 23, 2022.
- Experian. "The 10 Most Popular Vehicles to Lease in 2020." Accessed September 23, 2022.