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Leasing a car

A lease is a contract with another party (usually a car dealership) that allows you to borrow a vehicle for a set period of time in exchange for regular (usually monthly) payments.

The most common time frames are for three- or four-year leases.

Unless the contract includes the option to purchase the car at the end of the term, you’ll have to give it back once it’s over.

How does leasing work?

Your monthly lease payments will be considerably lower compared to the cost of financing a car.

That’s because you’re not actually buying the vehicle; you’re just paying the owner to borrow it and compensating for its depreciation. (Cars become significantly less valuable with time and wear-and-tear.)

What the car would cost to buy once you’re done with it is known as the “residual value.”

You may want to look for a vehicle that has a high residual value. While you’d have to pay more if you decide to keep the car, your monthly payments will be lower because you don’t have to compensate the owner for as much depreciation.

When trying to find a decent deal on a lease, you’ll also need to look at the “money factor.” It’s similar to the interest rate you’d pay on a loan — it’s also affected by your credit score — but it’s usually expressed as a small decimal, like 0.0015625.

You can convert that to the equivalent APR by multiplying it by 2,400. So 0.0015625 would be like an interest rate of 3.75%.

Pros of leasing

The biggest benefit to leasing is its affordability. So if you have champagne taste but a sparkling wine budget, leasing gives you the flexibility to drive a luxury or premium car.

Your monthly payments will be fixed, and all you’ll have to pay over that is gas and car insurance.

And if you’re leasing a new car, it will often be covered by the manufacturer’s warranty for the length of your term — meaning no extra costs for many kinds of breakdowns.

Cons of leasing

If you want to keep the car in the end, leasing certainly isn’t a cost-effective way to do it. You’ll just be spending extra money to drive a vehicle you don’t own for a few years.

You’ll also generally face mileage restrictions, so if you drive long distances, you’ll rack up fees for each extra mile you drive after you cross your mileage limit.

Since you have to return the car at the end of your term, you’ll have to be extra conscious of maintaining the car’s condition. If the car experiences excessive wear-and-tear under your care, you could end up paying the dealer hundreds or even thousands at the end of your lease.

These days, dealers are increasingly pushing wear-and-tear “passes” or insurance policies that will add to your monthly payment but protect you (to an extent) from surprises at the end of your term. But that makes leasing less budget-friendly.

Finally, leases are notoriously tough to get out of. If you can’t find someone to take over your lease, you could pay steep fees to terminate your contract early.

Does leasing work for you?

If you like driving new cars and you can live with the drawbacks, leasing can be a fun and affordable option.

But before you sign on the dotted line, ask yourself whether you feel financially stable.

When you lease a car, you need to be sure you’ll have steady income for the next three to four years because you’re expected to make those monthly lease payments reliably. And you can’t just sell the car if you can’t afford it anymore.

If that notion gives you pause, leasing may not be your ideal option. You may want to consider financing either a new or used car.

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Financing a car

If you can’t buy a car outright, financing offers another path to ownership.

Like leasing, you’ll make monthly loan payments, but once the term ends, you’ll fully own the car.

Financing will cost you more in the end than buying with cash, but you can mitigate the cost in a few different ways.

You can determine the monthly payments by using a car loan calculator, by choosing the tenure of the loan and amount of down payment you are willing to make.

How does financing a car work?

When you finance a car, you get a loan to cover the amount you can’t or don’t want to pay upfront.

The loan will have a fixed interest rate, meaning your payments will stay the same for the full length of the term.

You’ll repay the loan over a set period of time, like 48 months. The longer the term, the smaller your monthly payments — but the more money you’ll end up spending in the end.

While you’ll pay more to finance a car compared to leasing, you’re working your way toward paying off the cost of the car and owning it vs simply paying to use the vehicle.

Pros of financing

Leasing may be more affordable, but in the long term, financing is the more cost-effective option.

Once the loan is paid off, you’ll be free from future payments and you’ll have an asset you can sell if you want to recoup some of your costs.

And since you own the car, you can customize it however you like.

You won’t face any mileage limits or have to worry about wear-and-tear — unless the scratches and dings bother you personally, of course.

Cons of financing

In order to pay less in the long run, your monthly car payments will be much higher — meaning you’ll have less room in your budget to invest or cover urgent expenses.

And once the car is yours, any issues are yours alone to deal with. Some repairs can be extremely costly once the warranty expires, unless you prepay for an extended term.

To avoid unpleasant surprises, you’ll want to do plenty of research on the car makes and models that are best for the long haul.

Getting an auto loan at a fair interest rate can be challenging if you don’t have great credit. Some loan providers promise decent rates for all credit scores, but otherwise you may need to spend some time repairing or boosting your credit score.

Finally, if you want to get rid of the car you purchased with financing, the selling process can involve a lot of work; it’s not as easy as just handing the keys back to the dealership. You’ll typically need to list the car, negotiate on price and deal with car title transfers — unless you can find a company to handle it all for you.

Does financing work for you?

If you know what car you want and you’re able to manage higher monthly payments, financing is likely a better option.

To save money on interest, try to limit your financing term to 48 to 60 months and offer a larger down payment.

How much is a good amount for your down payment? Try to aim for 20% to 30%. If you can’t afford that much, look at less expensive cars or plan to save up more before you pull the trigger.

You’ll also want to explore different lenders so you can lock in a lower interest rate. Banks and dealerships don’t always offer the best rates.


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Sigrid Forberg Associate Editor

Sigrid’s is Moneywise.com's associate editor, and she has also worked as a reporter and staff writer on the Moneywise team.


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