Unless you’re buying a car outright, you’ll likely be leasing or financing.[cite::219::cite] While those lease ads can look quite tempting, low-interest financing deals should have your attention, too.
But, they’re two distinct financing types.
What’s the Difference Between Leasing and Buying a Car?
Leasing a car is like renting one for between two to four years, at monthly payments cheaper than rental fees. At lease end, you return the vehicle, pay any charges owed, and walk away.
When buying a car, you borrow the money from a lender, make set payments over the loan’s term, and once it’s paid, you own the vehicle free and clear.
Here’s how these contracts and costs differ.
Elements of a Standard Car Lease
Recognize the numerous car leasing terms uncommon to vehicle financing, but be sure to grasp the five essential components that influence your leasing costs. Then, negotiate each one for the best deal.
- Capitalized cost. This is the amount dealers will insist the vehicle actually costs. If you pay a higher capitalized cost reduction (or down payment), this number goes down.
- Money factor or lease rate. It’s equivalent to the car loan interest rate on the capitalized cost, and the lower yours is, the lower your monthly payment. These are shown as a fraction of a percentage, so multiply that number by 2,400 to get the annual interest rate.
- Residual value. This is what dealerships will insist a car’s worth at the end of the lease will be. Research this before you shop, then compare what you learn with what they tell you. Also, consider opting for a closed-end lease, so you won’t pay more if the car’s value is lower at lease end.
- Term. The vehicle’s lease length state in months. It’s usually about three years.
- Mileage allowance. This is the total number of miles you can drive under your lease. It’s usually expressed annually. If you drive more, you’ll pay for the extra miles at the end, but driving fewer miles doesn’t bring a refund.
Additionally, learn how to avoid mistakes while leasing—like forgoing gap insurance or renting too long—and know what to do near lease end.
Pros of car leasing include lower initial costs and monthly payments as well as driving a newer, higher-end car every two to four years without taking the depreciation of buying new. You'll also have lower repair and maintenance costs and no commitment to ownership.
Car leasing cons are the increased cost over time, early termination fees, and restrictions on using the vehicle like customizing and mileage use. You also must keep the car in near-perfect condition. Otherwise, expect to pay extra costs at lease end. Crucially, because you give the car back after the lease, you won't be building equity in your car as you make your payments, as you do when you finance.
Fundamentals of Financing a Car
For the lowest monthly payments and overall vehicle costs, research the car you’re buying before talking to lenders or dealers. Avoid overpaying for the car by renegotiating the car's retail price with the dealer and considering resale or trade-in value up-front. Then, negotiate the best deal on financing, including the loan’s interest rate (APR) and loan term.
Pre-approved financing from a bank or independent finance company can often mean better deals and loan terms. Dealer financing can be tricky, more expensive, and have the least favorable conditions, in many cases.
Pros of financing include no mileage or customization restrictions. You also own the car once its paid off and stop making car payments, so you could recoup some of your costs if you sell it. Financing cons are a more substantial down payment and monthly payments as well as the risks of total loss and depreciation.
Which Option is Best for You?
Leasing is best if you have excellent credit but are short on cash, drive carefully a limited number of miles annually, and want to drive a new car regularly. Financing is optimal for those wanting the most control over their car’s use and ownership after the loan is paid off.
Be sure to research each option carefully, watch dealer fees, and understand other tricks of the dealer trade to win at the car financing game and get the car you want for the right price and the best financial arrangement.