Summary: Should I Lease or Buy My Next Car?
There’s a reason why both of these options exist. The appropriate answer to the age old question of “Should I lease or buy my next car?” is going to be based on your personal circumstances. This article will break down what you should consider when deciding between leasing versus buying.
What is the difference between leasing and financing?
A lease is a contractual agreement to borrow a vehicle for a set period of time for a predetermined cost. When the lease term is complete, you either return the vehicle or purchase it from the dealership at a purchase price decided upon when the lease is initiated. As a vehicle is used, its value gradually declines. The price you pay to lease a vehicle is therefore the difference between the current price of the vehicle and its estimated residual value at the end of the lease, plus interest charges. You are paying for the depreciation in the value of the vehicle for the time that you’re borrowing it.
Financing a vehicle is simply borrowing money to make the purchase. Payments are higher than equivalent vehicle leases because you are paying back the entire purchase price of the vehicle (plus interest charges), not just the difference between its current value and residual value.
When is it better to lease?
Since leasing carries lower monthly costs than financing, you will be able to drive a vehicle you may not otherwise be able to afford. While conspicuous consumption isn’t a fiscally prudent move, it may be relevant given your individual circumstances. You’re also driving the car when it’s new and less likely to have issues. Since the vehicle is new, it will most likely also be on manufacturer’s warranty for a significant portion (or all) of the lease term. This provides greater clarity to your total vehicle expenses and reduces your liability. Further, if a vehicle is damaged in an accident and repaired, its resale value declines. This isn’t your problem if you’re leasing.
Leases also present you with what effectively amounts to a call option on the purchase of the vehicle. At the outset of the lease, you will receive a quote for a locked-in purchase price that you can exercise at the end of the lease term. If the price is attractive relative to market prices of similar cars (as we witnessed during the pandemic), then you can purchase the vehicle and keep it or resell it for a profit. If the purchase price isn’t attractive, then you can simply walk away at the end of the lease term.
However, there are associated risks to the consistency and stability of lease payments. Leases are contracts that are difficult to get out of early. If you need to exit your lease for whatever reason, you will more than likely face a significant financial penalty for doing so.
The concept of “building equity” is a bit misguided as it relates to vehicles given the general rapidity with which they depreciate. Yes, leasing perpetually is more expensive than buying a car and keeping it on the road for as long as possible, but that’s only because of the more rapid pace of depreciation early in a vehicle’s life cycle. Building equity in a home is more of a consideration because property generally increases in value over time; this is not the case with vehicles.
If you know that you like driving newer cars, you want minimal hassle for vehicle maintenance, and you have stable cash flow, leasing is the better choice.
When it’s better to buy
In the long run, the cheapest way to drive is to buy a car and keep it until the repairs are no longer economical. A vehicle loses value much more rapidly in its first few years of life, and these are the years that a lease comprises. If you are always leasing, then you will always be paying for the first 3 to 5 years of depreciation of a vehicle.
You also have a contractually binding burden of care when leasing a vehicle, which must be returned in “showroom condition”. This is a significant consideration if you have kids. Excess wear-and-tear charges upon completion of a lease can be punitive. Mileage restrictions present a similar issue, as dealers impose these limits to maintain the resale value of the vehicle.
Buying a reliable vehicle that holds its value well will save you money relative to a lease, but the benefits won’t be truly realized until later in the life cycle of the vehicle. You have to be comfortable with the prospect of driving an older car if you want to keep costs down over time.
Longer term car loans are often used to keep payments low, but they carry their own risk. One of the strangest repercussions of Covid-19 lockdowns was surging used vehicle prices. This is not the normal state of the vehicle economy – since resale values of cars drop off quickly, those with longer-term loans can quickly get “upside down” on their loan and owe more than the total market value of their vehicle. If faced with pressing financial issues, the price you receive for your car likely won’t be sufficient to pay off the loan.
There are many people who get by without a vehicle. It is a nice-to-have disguised as a need-to-have. The choice to lease or buy is important, but living within your means matters more.
For more articles similar to this one (Should I Lease or Buy My Next Car?) by Max Kirouac, click here.
Opinions are those of the author and may not reflect those of BMO Private Investment Counsel Inc., and are not intended to provide investment, tax, accounting or legal advice. The information and opinions contained herein have been compiled from sources believed reliable but no representation or warranty, express or implied, is made as to their accuracy or completeness and neither the author nor BMO Private Investment Counsel Inc. shall be liable for any errors, omissions or delays in content, or for any actions taken in reliance. BMO Private Investment Counsel Inc. is a wholly-owned subsidiary of Bank of Montreal.
