New cars are a huge financial commitment, and not a very smart investment on paper. Edmunds.com says a new car loses 11% of its value on average when it leaves the dealer lot. And after the first couples years of ownership you can expect your new wheels to depreciate 20% to 40%. (Depreciation is based on use, which is why those initial miles off the lot decrease the value so much–the value of what once was new gets shocked when use begins.) The problem with such rapid depreciation of vehicles is you can find yourself in an upside-down investment (i.e., the amount you owe is more than the value of the item). This negative equity can be problematic if you want to trade your car in later because you’ll essentially have two car payments–the monthly payment, and down payment, on the new car and whatever is leftover from the loan on the old one. The likelihood of upside-down investments may drive new car owners to consider leasing. Well, that and driving a sweet new car ever few years. There are, however, pitfalls to leasing and buying, along with many benefits to each. So if you’re in the market for a new ride, here are the highlights to consider.
Down Payment: When you purchase a car the dealer typically asks for a down payment, usually around 10%. Like a house, 20% is the accepted standard to lower your monthly payments. With vehicles, this number serves another purpose. Putting 20% down will essentially cover the first year’s depreciation. This will prevent you from getting upside-down on your first day as a new car owner. If you lease a car, though, dealers may waive the down payment altogether without putting a hurting on your monthly bill.
Monthly Payment: When leasing, you’re essentially renting a car for a period of time, typically 24 to 48 months. In that time, you’re paying only for use, or in other words the depreciation. Compared to paying a loan that earns interest, monthly leasing costs are much less than an owner’s payments and you’ll never go upside-down. However, you’ll also walk away from a lease just as the depreciation begins to slow down, so you would’ve started to build equity at that time had you owned the car.
Number of Payments: The greatest benefit of buying a car is one day you’ll actually own it. At some point the payments will stop. When leasing, you’ll always have a car payment. Granted they’ll be much lower and you’ll be driving a new car more frequently, but the money you’re spending isn’t really working towards anything.
Mileage Freedom: When you buy a car, rack up as many miles as you like. Leasing, on the other hand, may limit your driving habits. The average driver puts about 15,000 miles on the odometer each year, so lease agreements usually specify that drivers cannot put more than 12,000 to 15,000 miles on leased cars per year. 15 to 20 cents per mile is a typical charge worked into lease agreements for additional mileage. For example, if you drive 3,500 extra miles during your lease, expect to pay about $700 when you turn the car back in. Also, if you drive much less than 15,000 miles per year, buying may be the better option because you’re not paying for a predetermined depreciation rate, which is ultimately determined by the “average driver’s” mileage.
Turnover: Leasing a car locks in a resale value, making it easier to trade in. A closed lease agreement means you turn the keys back in at the end of the term and get a new lease agreement and vehicle if you choose. If you love the car, an open agreement will allow you to purchase the car at the end of the term. It’s not so easy when you buy a car, especially if you go upside down. You’ll have to haggle with dealers on trade-in values or try and sell the vehicle on your own. Either situation could leave you with less cash for a future trade.
Buying or leasing really comes down to your long-term plans. If you crave the newest rides and want more cash in-hand, leasing offers less up-front costs and lower monthly payments. Buying a car is more expensive, but if you’re in it for the long haul those payments can eventually work towards something concrete: equity and ownership.