Leasing a car vs. buying: The pros and cons

Before we dive into this topic, let’s set the stage with an example.

Say you’re considering a new car with a sticker price of $34,000. Buying it with a 7%, four-year loan and a down payment of 20% ($6,800) would leave you with a payment of $650 a month.

Lease the same car – after paying a one-month refundable security deposit – and your payment would be $450 a month. Leasing saves you $200 a month, with only $450 down, not $6,800. This is why leasing is so popular.

But “Is it better to lease or buy a car?” isn’t such a simple question to answer.

Why lease payments are so cheap

Car ownership has three parts:

1. Equity (ownership)
2. Depreciation (loss in value over time)
3. Interest expense (on the loan, if any)

When you finance the purchase of a car, you pay for all three parts, and you’ll own the vehicle outright in a few years. But if you lease, you’re paying only for use of the vehicle.

So, you’re covering the car’s depreciation and interest, not the equity, and you return the car at the end of the lease term. This is why monthly lease payments are lower than purchase payments.

Leasing, quite simply, is the difference between owning a car and borrowing one.

Why a car dealer wants you to lease

If you lease a car, you pay the lease amount each month for the term of the lease. Then you give the car back, giving the dealer the chance to resell it.

This means the dealer doesn’t have to charge you (the first buyer) the full manufacturer’s suggested retail price, or MSRP; you pay only the difference between what the car is worth today and what it will be worth a few years from now when the lease term is complete. Leasing, then, features lower monthly payments because dealers expect the car to retain a certain value, also known as the residual value. The second buyer then pays the residual value – or close to it – when they purchase it as a used car.

Cars can make better lease deals when they retain more of their value – the higher the residual value, the lower your lease payments.

Is it better to lease or buy a car? Here’s what you should consider:

How many miles do you drive per year?

In most leases, you’re allowed to drive only 10,000 to 15,000 miles per year. Anything more will cost you up to 25 cents per mile.

So, if you drive a lot, it can be cheaper for you to negotiate a lease with a higher mileage limit – though it may have a higher monthly payment. If you don’t, you may be able to negotiate a lower lease payment.

How long do you plan to keep the car?

Leasing is best for people who keep their cars for four years or less. Remember that when leasing, you never enjoy a payment-free month. At the end of the lease, you must turn in the car and start the process over with a new lease or purchase contract.

If you like to keep cars for seven or eight years, you may find that leasing is more expensive than buying over the long term.

How much do you value new technology?

Cars are now also pieces of technology, seamlessly connecting to your other tech – even integrating artificial intelligence to the point that they can drive themselves – and getting ever-safer and more comfortable. While driving a car for 10 or more years might have made a ton of sense in the past, you may find that those leaps forward now make it worth switching up your car every few years.

One particular piece of tech that’s rapidly evolving: electric vehicles. If you’re interested in an EV but hesitant to pull the trigger, leasing could give you a few years to see how the tech changes – but still allows you to drive an EV now, knowing that you can turn it back into the dealer if you don’t end up liking it or if you want to quickly access future advances in the technology.

How does the math work out?

The math usually works out in favor of buying a car if you’ll have it for more than a few years. But the supply problems that hit the car market during Covid have continued to impact used car inventory and prices are still higher than they were in 2019.

According to CARFAX, a plummeting number of leases during the early pandemic means there are not that many cars coming off leases currently, and that could even raise prices further for the certified late-model used cars (i.e., former leases) that we normally recommend. It could make a lease more financially attractive than usual.

Again, EVs can be a special case. Certain EV purchases are eligible for a $7,500 federal tax credit in 2024, and many dealers are passing the value of the credit on to people who lease, as well. Because the credit can be the same whether you buy or lease, but lease payments are lower, the credit could be more impactful when you lease. Leasing also gives you more EV model options because of a quirk in the legislation, and it means you won’t have to worry about qualifying for or claiming the credit.

A quick note about running the math: Never compare monthly payments only. You want to understand the full cost of each option, including the money you put down, fees and interest.

money-saving tips when leasing vs. buying a car

If you’ve decided to lease, here are three items to keep in mind:

Consider gap insurance

This is an important – yet often overlooked – element of leasing.

Gap insurance covers the difference – or the gap – between the depreciated value of the car and what you still owe. Hypothetically, your contract might say the car’s residual value at the end of the lease will be $15,200, but the car’s actual value will be only $10,000. If you wreck the car three months before your lease expires, the insurer will pay the dealer (who owns the car) the actual market value, which is $10,000. But your contract says the residual value is $15,200. That means you’re responsible for the other $5,200.

To help avoid incurring losses due to accidents, confirm if your lease contract includes gap insurance. You may also be able to get it cheaper through your insurer – just make sure you’re not paying for it twice.

Avoid the cap cost reduction

When someone buys a car, the more money they put down, the lower their monthly payments typically are. Similarly, to lower your lease payments, you can make a cap (short for capitalized) cost reduction, which is a large, one-time payment made at the start of the lease. As with a down payment, the more you pay in cap cost reductions, the lower your monthly payments. However, this is where the similarity ends.

Remember that when leasing a car vs. buying, you do not own the vehicle. So making a cap cost reduction is like a down payment on property that you don’t own.

One example of how this can hurt you is if your car is totaled in an accident soon after you lease it. Your insurance provider will cut a check to the dealer to cover your remaining payments – which are nice and low thanks to the money you fronted! But you likely won’t get any of that money back. It’s gone.

Had you not paid the cap cost reduction, your insurance would still pay off the higher remaining balance, but you’d keep your cash in your pocket. That’s why we often educate our clients on why not paying the cap cost reduction is an important consideration – no matter how much it reduces your monthly payments.

You might be able to ask the dealer to let you make multiple security deposits instead of a cap cost reduction. This will have the same effect of lowering payments, but you’ll get the money back when you return the car.

Forgo the optional equipment in a car you’re not buying

It may be enticing to get all the extra bells and whistles on your new car, but remember, you’re just borrowing it.

Hypothetically, let’s say you’ve negotiated the lease of your next car, but then you decide to have the dealer install mats, fancier rims, an iPhone adapter and the latest navigation system. To cover the cost of all these items, the dealer could add something like $50 to the monthly payment.

You might think this is a great deal because you’re paying for the options over three years and the dealer isn’t adding any interest.

But when the lease expires three years later and you return the car, the mats, rims, iPhone adapter and navigation system go with it. That means you paid the full cost of owning those items, but only rented them for three years.

A better strategy would be to incorporate the cost of the options into the overall price of the car and then negotiate the lease price based on the new total. That way, you’re only paying for the options during the term of your lease.

When leasing a car, keep in mind that you’re renting the car and everything in it. Don’t pay the costs of ownership when you lease.

Other considerations for leasing vs. buying

Leasing and taxes

In most states, you’re liable for sales tax when leasing, even though you don’t own the car. If your state levies a personal property tax, you’ll have to pay this, too. Make sure you understand the tax implications as you decide whether to lease or buy your next car.

Don’t lease beyond the car’s warranty

If the car comes with a two-year, bumper-to-bumper warranty, for example, get a two-year lease. By opting for a three-year lease, you could be stuck with huge repair bills in year three – on a car you don’t own and plan to return to the dealer.

Leasing for business

Leasing makes great sense for business because you can deduct the cost as a business expense. You can also deduct the associated costs, such as maintenance, gas or mileage, insurance and registration fees.

Your planner can help you decide

Since a vehicle is a large purchase, talk with your financial planner before you decide whether to lease or buy your next car, how much to put down and whether you should finance. The right decision can save you thousands!

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