To Lease Or To Finance

By Teresa Cortes

December 29, 2014 5 min read

Considering that the scenario of an individual's buying a new car upfront with cash is an uncommon one, leasing and financing remain the two considerable options when it comes to acquiring a new vehicle. However, many auto consumers are puzzled over which approach may make the most financial sense for them. Indeed, there are a number of financial factors to consider when ruminating over the option to lease or to finance.

First and foremost, there is often a sizable difference in the initial financial investment between the two options. Leasing a car often requires a significantly lower down payment than financing. Sometimes lessees can even drive away with a new car after no money down at all. On the other hand, Liz Opsitinik of U.S. News & World Report points out the much steeper financial expectation when financing a car: "Many lenders require about 10 to 20 percent down when taking out a car loan. On a $30,000 vehicle, that's $3,000 to $6,000." For those with little money to put down on a car, it appears that leasing is the better option.

Of course, in both scenarios, the higher the down payment, the lower the monthly payment one will be responsible for. Yet in general, monthly lease payments are much lower than the monthly loan payment on a car one pays while financing. This is because when you lease a car, payments are based off the difference between a car's starting value and its residual value (described by leading automobile experts at Edmunds.com as "the amount you can buy the car for at the end of the lease, if you decide you want to purchase the car"). Therefore, the monthly payment for leasing a vehicle is based on the value of the car that you "use" during the time that you lease it. Manufacturers will anticipate what the residual value of a car would be at the end of your lease term -- based off of data collected on similar vehicles -- when making up a contract. Again, for those who have little money to put toward a monthly payment, leasing a car seems to be the more sensible option here.

The lower payments of a lease may appeal to most automobile consumers; however, there is one potential problem that can arise from this process. That is, some manufacturers will inflate the residual value in order to offer a lower monthly payment (making a lease much more enticing), also called a subvented lease. This means that if you decide to purchase the vehicle after the lease term ends, it's very likely that you will end up paying more than you could for a similarly used vehicle that could be purchased on the market, since you pay the amount of the residual value that was agreed upon in the contract, which was inflated and will be more than it should be. If you believe that, you may wish to purchase the car at the end of the lease. Edmunds.com recommends anticipating this as a potential problem and to consider and investigate residual values before signing a lease contract. Unfortunately, there are still unpredictable factors that can affect the residual value of a car at the end of a lease term, such as a recession, which cannot be prevented.

One of the greatest advantages of financing a car over leasing one is that each monthly payment made builds equity while financing. Of course, this is simply because those who choose to finance a car will keep the car at the end of the term, whereas lessees must return it to the dealership. Therefore, for those who know -- or even have an inkling -- that they would like to keep their car, financing may be the better option because purchasing after leasing runs the financial risk of the residual value's being higher than the actual value of a car by the time the lease is up.

There are also mileage restrictions and potential impending charges per mile over the limit that lessees must be aware of. This could be a problem, depending on the lifestyle of the lessee and how many miles he or she anticipates driving.

The consensus among experts in the finance industry seems to be that the best overall decision between leasing and financing is based substantially on lifestyle preferences and situations. For those who do not have as much money to invest in a car upfront or for monthly payments, leasing may be the better option. However, those who find it worthwhile to front the higher down payment and monthly payments end up with a car that is theirs to keep and avoid the financial risks that come with mileage restrictions and a potential inflated residual value. This makes the choice between leasing and financing a very personal one indeed.

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