For a lot of people, driving your car is a natural process that requires little thought beyond keeping yourself and those around you safe. Getting a new car, however, is the most stressful and complicated process of ownership for the majority of drivers. You spent hours upon hours poring over internet reviews, hearing anecdotal stories from friends and family, and test drove everything under the sun until you finally whittle the list down to your perfect choice of car. Then, without warning, the salesman lobs this grenade at you:
“So were you thinking of paying cash, financing, or leasing?”
From my experience being on the side of the desk with all the pens and pamphlets and model representations of the cars on the show floor this one question, more than anything, is what blindsides shoppers. They stare like a deer caught in the headlights, you can see the gears in their head which were flying at full speed come to a crashing halt, and with hesitation that betrays their lack of preparation they question back “What’s the difference?”
You might have found yourself in this position, or you might be dreading it as you do your research, but the good news is that the options aren’t nearly as difficult to navigate as they were before as open-ended leases have mostly faded to obscurity. For the sake of this article we’ll assume that the buyer is not paying cash, as the car is brand new and more expensive, and focus on the two options of financing versus leasing. It really boils down to the ultimate question of what you intend to do with your car.
Leasing has many different customers, but it really falls into two main buckets: You lease because you’re the kind of person who upgrades to the latest and greatest phone the instant you’re eligible or you lease because you don’t have a crystal ball which can predict where you’ll be in the next couple of years. The first group is straightforward; the advantage of leasing is that you’re only obligated to pay the portion of the car you use (meaning the mile allotment and the term in months). You don’t have to worry about long term reliability issues or cost of ownership, nor do you have to feel envious of model year updates and refreshes as you can always be on the top of feature sets. The latter group is more about your current life situation. If you are in school, believe you may be moving soon, or that your vehicle needs may change such as when starting a family then leasing provides a very short commitment to a vehicle that, in the worst case scenario, can typically be turned in early by communicating with a dealership. If you’re a couple starting out, having a two-year lease on a small commuter car will allow you the flexibility to exchange for a larger car if you decide to have kids or large pets.
There are a few myths, however, when it comes to leases and a lot of this comes from marketing. Manufacturers want you to lease because they will make money from the interest (known as ‘money factor’ in leases) and when the vehicle is returned they have a young, low-mileage preowned vehicle that can sell in a certified pre-owned program which has skyrocketed in popularity these past several years. For the it’s a win/win situation but this leads to some marketing implications that can confuse buyers. The biggest myth is that leasing is cheaper than financing, which may be true for some models but its not a rule. Leasing terms are based on what the manufacturer predicts the value of the vehicle will be at the end of the term, known as the ‘residual’. If a vehicle has a higher residual, the lease payment that gets broken up from the remaining value of the price tag becomes smaller, and a vehicle with a lower residual will thus have higher payments. Typically, vehicles with a federal and/or state tax credit, such as hybrids, plug-in hybrids, and electrics, will have better lease terms because the company will use the tax credit as a rebate instead. High performance and commercial vehicles tend to have very high, poorly valued lease terms because the company expects these vehicles to be heavily used and have high depreciation. Most cars, however, will fall into a category where the payment terms are roughly the same as finance, so why would you finance?
Financing makes the most sense with customers who tend to keep their cars for a long time. If you imagine yourself owning a car for more than five years then there’s little argument against just purchasing the car instead of leasing. Financing also allows you the option of refinancing, in which you set new terms and distribute the payments as appropriate. This works great for someone who wants to keep the car but would like to lower their payments and is comfortable with extending the terms. Much like a lease, you can also trade your car in should you find your needs change. Trading in this way can be more difficult as you owe for the entirety of the vehicle which can lead to an upside down loan.
So when you’re looking for a new car, ultimately consider what purpose you’re going to be using it for and whether it makes sense to go with a flexible, short term lease as opposed to a longer term and more stable purchase option. Most dealerships don’t have any particular incentive to push leases over purchases, as long as they’re selling new cars they’re happy, so if you’re unsure which way to go have them write up what both options would look including the applicable taxes and the terms. Having the two options side by side for a specific car can be incredibly helpful in making your decision.