Some people consider a car a personal statement about themselves, while others consider it a way to get from Point A to Point B. But one thing is usually true of all cars: unlike houses, they almost always decline in value over time.
So when it comes to deciding whether to buy or lease your next car, you need to remember that it’s a depreciating asset—then run the numbers. But first, make sure you know the difference between car loans and leases.
What’s the difference?
A car loan allows you to purchase an automobile outright. Instead of paying cash for the entire cost upfront, you pay cash for part of the cost—your down payment—and finance the rest through a loan that requires monthly repayments. Once you’ve paid off the loan, the car is yours—no matter what shape it’s in or how many miles you’ve driven it.
A car lease is like renting a car for a specific period of time—you never own it outright, unless you choose to purchase it at the end of the lease term (often two or three years). You often aren’t required to make a down payment, but you do make monthly payments for the period of the lease. In addition, when the lease expires, you may be required to pay an extra amount to cover additional miles you’ve driven beyond the terms of the lease or damage to the car.
Questions to ask yourself
When considering whether to buy or lease a car, ask yourself the following questions. Your answers may help you decide which option is right for you.
| Buy | Lease | |
|---|---|---|
| How long do I plan to keep this car? | If you keep your cars for many years, buying generally makes more sense. Once you’ve paid off your car loan, you’re done with interest payments. However, older cars cost more money in maintenance. | If you like a new car every two or three years, a lease may make sense. The old saying, “your car depreciates the minute you drive it off the lot” applies here—so buying a new car every few years can get expensive. However, if you lease a car for many years, the interest rates can add up. |
| How much money can I afford for a down payment? | If you can afford a significant amount, it may make more sense to buy. Every dollar you borrow—through a car loan or through lease payments—comes with an interest charge. The more you pay in down payments or cash, the less interest you pay. | If you can afford little or no money in a down payment, you might consider a lease. You cover the entire use of the leased car through your monthly payments (after little or no down payment), except for any charges that may apply for mileage or use once the lease is up. |
| How many miles do I drive each year? | If you drive a lot—say, 15,000 miles or more—consider buying. Your car loan doesn’t have a mileage charge, but leases may require you to pay additional money for driving beyond the annual mileage limit that comes with your lease. | If you don’t drive many miles, a lease may make sense for you. If you don’t exceed your lease’s annual mileage limit, you won’t pay a mileage charge when you turn in your car. However, leases may require you to pay additional money for driving beyond the annual mileage limit that comes with your lease. |
| How badly do I treat my cars? | If you’re hard on your car, you should consider buying it rather than leasing, due to the additional charges that may apply when you turn in a leased car. | If you’re not hard on your car and have just ordinary wear-and-tear, a lease may make sense. |
Want to learn even more?
Auto loan basics
The three important pieces of an auto loan are your down payment, your interest rate, and the length of financing. It’s important to learn how these elements will work together so you can determine exactly how much your car will cost you over time.
- Down payment: Try to put down as much as possible without jeopardizing your other financial goals and emergency fund. Many experts recommend putting down at least 20% of the purchase price. Paying more upfront may reduce the amount of your monthly payments and could result in a lower interest rate.
- Interest rate: The APR (annual percentage rate) is the actual interest rate you pay annually on the unpaid balance of the loan. Your interest rate will largely depend on your credit score. Beware of zero percent financing offers. Most interest-free financing offers require loan terms of three years or less. This means your monthly payments may be quite large as you’ll have a shorter period of time to pay off the loan.
- Length of loan: The longer your loan term, the more it will cost you—and the longer it will take you to reach a point where you no longer owe more than the car is worth.
If you decide to get a loan, shop around. You can obtain an auto loan from a bank, credit union, or other financial institution. These will usually offer lower interest rates than may be available from a car dealer. You can have these loans approved before you even go shopping. You can also get financing through the car dealer or from the auto manufacturer. However, remember that it's in the car dealer's best interest to finance at the highest rate possible, so look at what you can pay overall—not just the monthly amount.
Using a home equity loan to pay for your car instead of an auto loan may be tempting if it’s available to you, as interest rates are often lower and the interest is tax deductible. However, if you go this route, make sure you can afford the payments. If you default, you could lose your home.
Auto lease basics
Leasing may be appropriate if you want a new car every few years, you want to avoid a down payment of 10% to 20%, and you keep your vehicle in good condition to avoid end-of-lease penalties.
Car leases typically carry lower monthly payments, but expire at the end of the lease term. However, leases may cost more if you drive the car over the amount allowed under the terms of the lease.
Words of wisdom—and caution
Don’t forget that cars are usually depreciating assets, meaning they’re typically worth less over time. If you have a long-term car loan and wish to sell your car before the loan is paid off, you may not recover enough when you sell it to pay the outstanding loan balance. This is where car loans can be like mortgages in today’s market—you can be “underwater” on a car just like you can be underwater on a home loan. So don’t buy more than you can afford.
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Find the right fit for you
There is no one-size-fits-all answer to buying or leasing a car. Consider your budget, lifestyle, and goals before choosing.
