New cars are a huge financial commitment, and not a very smart investment on paper. On average, a new car loses 11 percent of its value the moment you drive it off the lot. And after the first few years of ownership, you can expect your new wheels to have depreciated 20 to 40 percent.
The problem with such rapid depreciation of vehicles is you can find yourself in an upside-down investment, which means 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 on the new car and whatever is left over 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 new car every 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 some highlights to consider.
When you purchase a car the dealer will typically ask for a down payment. Like a house, 20 percent is the accepted standard to lower your monthly payments. With vehicles, this number serves another purpose. Putting 20 percent 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 strain on your monthly bill.
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 toward anything.
When you buy a car, you can 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.
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 vehicle.
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 toward something concrete: equity and ownership.