When and why you should lease a car instead of buying
The pros and cons of leasing a car
- It's generally cheaper to lease on a monthly basis, but you don't get to keep the car.
- Leases are typically set for two to four years.
- Mileage restrictions on leases range from 10,000 to 15,000 miles a year.
- Ending the lease early results in early termination fees.
- You may have the option to purchase the car when the lease ends.
You’re in the market for a new vehicle and trying to decide whether it makes more sense to lease a vehicle or to buy one. Which is better for you? The answer depends on several factors, as each option comes with its pros and cons.
What is a lease?
A lease is a contract between a property owner, the lessor — in this case, usually an automaker, finance company or bank — and the user of that property, the lessee, to use the property subjected to certain terms and limitations for a specified amount of time, for a specified payment, according to the Federal Deposit Insurance Corporation (FDIC). When you lease a vehicle, you’re essentially renting it for a set period of time. Depending on the lease terms, you may have to provide a downpayment upon signing the lease.
Only a small number of banks offer consumer leases; most leasing is done by specialized bank subsidiaries, vehicle finance or other finance companies, or directly by retailers, according to the FDIC.
Federal regulations are in place to ensure consumers are provided with accurate lease terms before signing a contract. The information allows consumers to more easily compare leases, as well as compare the cost of leasing with the cost of buying on credit or paying with cash, the FDIC states. Regulations also limit balloon payments due at the end of a lease, and regulate advertising.
Do you want lower payments or more equity?
If you’re trying to keep your monthly payments low, leasing may be your best bet, as the monthly payments are often lower than the payments on a comparable auto loan.
But when you’re leasing a vehicle, you’re not earning any equity in the vehicle like you would with a loan. And when the lease ends, you don’t get to keep the vehicle — you must return it, unless you decide to purchase it.
Leases are typically set for two to four years, and include mileage restrictions that typically range between 10,000 and 15,000 miles per year, according to the Consumer Financial Protection Bureau. Going over the mileage restriction will most likely result in fees. The restrictions are in place because the more miles the car has, the more its value depreciates.
Do you mind less freedom?
Buying a car gives you greater freedom than if you lease it: You can sell or trade in the car for a new one any time you choose. If you want to ditch your leased car before the lease ends, you will likely be hit with fees for breaking the lease early.
With a standard auto lease, the majority of the monthly payment covers the amount the vehicle will depreciate over the lease term, plus a rent charge, according to the Consumer Financial Protection Bureau.
The Bureau offers the following steps to calculate a typical monthly lease payment:
- Decide on the cost of the vehicle with the leasing company, less any trade-in, down payment or rebate
- Decide on the length of the lease — typically two to four years
- The leasing company will determine the vehicle’s “residual value” — the vehicle’s worth — at the end of the lease.
- The amount of depreciation is calculated by subtracting the residual value.
- The monthly payment is calculated by adding the estimated amount of depreciation during the term of the lease, plus the rent charge, taxes and fees; and then dividing that amount by the number of months in the lease term.
When to buy a car?
The predetermined residual value is typically the cost to buy the vehicle once the lease ends, known as the buyback price.
Whether it’s a good deal to buy the vehicle or not depends on the vehicle’s market price at the time the lease ends. It also depends on your eligibility for an auto loan. Talk with an auto lender to know what terms and rates you will be able to get. In addition, head to car-valuation websites and see how the market rate compares to your leased vehicle’s buyback price. When making the comparison, take into account any fees you might owe for going over the mileage restrictions or for excessive wear and tear.
If you can buy the same model for less than the buyback price, you’ll probably want to hand the car over when the lease ends. If the buyback price is less than the market rate, however, it may be best to purchase your leased car and either keep it or resell it.
Even if the market rate is lower than the buyback price, there may be non-monetary factors that influence your decision. For example, if you’ve leased a new vehicle, you will have the benefit of knowing its entire ownership history. Take all factors into consideration before making your final decision.