Should I Finance or Lease a New Car? Which is Better?
Which option is better? Which will save you more money?
There are advantages and disadvantages to buying or leasing a new car. What is better for you depends on your situation and your habits. There is not a 100% financially beneficial option every single time, it depends on the situation. You should always inquire about both options to compare which would be best for you.
Financing a Car
When you finance a car, you are the owner of the car. You borrow money from a lender and pay the interest for borrowing those funds. This is a simple concept of borrowing money and owning an asset. In the financing case, you will be responsible for the pitfalls and benefits of the value of the car. This is straightforward, you are making a bet that you can preserve the value of this car better than the average. Also, this would be beneficial if you believe the car will appreciate in value.
Leasing a Car
When you lease a car, the dealership is the owner of the car. You are still paying interest but rather than paying down the principal of the loan you are paying for the depreciation of the car or the value it loses each year. When you lease the dealership is responsible for the pitfalls and benefits of the value of the car. The lease will come with terms, most importantly an annual kilometer limit and a predetermined buyout price at the end of the lease. This option you believe the car will depreciate faster than that buyout price.
In comparison, the main aspect is what you believe the value of the care will be in the future. These terms are based on statistical averages of previous cars and drivers. When you finance, you are making a bet that the value of the car will be greater than the buyout price determined in the lease. For leases, there is a safety net built in and that is the predetermined buyout price. If you take very good care of the car or its value appreciates you can buy the car (at a pre-determined buyout price) and sell it yourself. Alternatively, if the value is lower, you can just give it back. This does place more risk on the dealership when you lease and more risk on you when you finance.
Lessees pay less than half the tax
One large benefit of leasing that many people are unaware of is the reduced sales tax on a lease vs. financing. Sales tax is calculated on the value of the product you are purchasing, if you finance a car that costs $60,000 you will pay sales tax on $60,000. If you lease the same car the sales tax is calculated on the total of all your payments which is usually less than half and then if you buyout the car in the end you will pay the remaining amount. Lessee’s will pay every time a new lease is taken out, but those who finance will pay it all upfront.
Which is better for you?
There is no option that is better 100% of the time. But, depending on your situation and habits you could benefit one way or another.
If you drive a lot of kilometers per year
Leasing may be an option if the lease allows it. Cars will lose approximately 20% of their value in the first year and 10-15% every year after that. This may depreciate faster with more kilometers per year. If you can fit under the cap, leasing is a better option.
If you are bad at maintaining cars or like to push your car to the limits
Leasing would likely be a better option for you. This car may depreciate faster if not treated correctly.
If you drive very little
Financing is most likely a better option because it will likely depreciate slower than the average. The lease terms will likely not be in your favour and the car's life would be extended beyond the average.
If you are good at maintaining a car or can maintain the car yourself
When leasing, the maintenance is also built into the cost, if you can save money here or require very little maintenance then financing may be a better option for you.
Cash flow is low
If cash flow is an issue, then leasing is usually a better option because of the lower payments. Financing payments include payments to the principal of the loan and the balance of the loan will likely exceed the car's value for the first couple of years.
You like to switch cars often
Leasing would be a better option for you, with leases you can get a new car with every lease.
You prefer to keep cars for a long time
If normally keep cars for a long period and are good at maintaining, then financing could be a better option for you. Over a long period, financing will save you money if your maintenance cost is low.
There are many scenarios to play through when thinking of financing or leasing. In theory, they are similar but someone who drives very little or saves somehow on maintenance should benefit from financing vs. leasing.
Finance vs. Lease by the Numbers
To complete this I have broken down purchasing two vehicles, breaking down all the numbers top to bottom to see which is better financially. This does not factor in maintenance of the vehicle, but rather just pure payments. For the depreciation I used www.caredge.com which gathers used vehicle prices over the years to determine the depreciation value of a car, assuming 20,000 km per year. I chose more common SUVs the Volkswagen Tiguan R-Line and a more expensive Acura RDX A-Spec as the two options. I pulled the actual calculations of the financing and leases off the websites of Volkswagen and Acura in March of 2024. Keep in mind this is “back-of-the-envelope” math therefore there will be some actual variations in real-life execution. Here are the results:
The results are as expected. The two options are very similar, but overall, the total payments were less in the leasing scenarios, but this makes sense due to the lump sum payment being due after 4 years, as opposed to being paid over 7 years.
Leasing Financial Benefits
Lower payments - Overall, the payments are lower when leasing. A large part of this is due to the decrease in interest costs, due to a lower interest rate. In both scenarios, this is 2-3% higher and does result in thousands of dollars over the years.
End-of-term flexibility - At the end of the lease you will have the ability to either purchase the vehicle (at the residual value) or give it back. This flexibility gives you the ability to make a better financial decision at the time.
Leasing Financial Drawbacks
Maintenance Costs - Often when you take on a lease you will be required to maintain the car through the dealership, this can often be more expensive. This can add a lot of extra cost over time, this could be offset by the increase in interest cost.
Breaking the Lease - Depending on the vehicle and situation, breaking a lease may be costly. This may come with a penalty or “work out” depending on if you can transfer the lease or not.
Financing Financial Benefits
Maintenance Costs - Often you will be able to save on car maintenance due to the ability to shop for the best prices or do the work yourself. This can save you on costs over time.
Sell whenever - When financing you are in control and can change the car at any time. This can work in your favour in the case of a life change or life event. This may not be the case when breaking a lease.
Financing Financial Drawbacks
Higher Payments - Financing payments are higher due to the higher interest rate. When leasing you pay for expected annual depreciation, which makes them more comparable on higher-end cars that depreciate faster. But, over time the interest on a financing loan is greater than a lease and could amount to thousands of higher interest costs.
Lemon Cars - Sometimes cars are just lemons, for whatever reason they come with more problems. If this is the case, then you are stuck with this car. In a lease scenario you can give it back after 4 years, but when financing it is yours.
Overall Comparison
Between Leasing and Financing, there is not a clear winner. From a financial perspective leasing might have a slight edge depending on the car and due to flexibility at the end of the term. But it could be riskier if your annual kilometers driven per year increases. The true savings in either option is keeping a good car with low maintenance for a long period of time. That is when the true financial savings come into play, and you are no longer paying interest and the depreciation is less each year. The financial impact is more based on your situation and which option fits you better. Leasing would likely be better if you fit within the confines of the terms. Financing would likely be better if you could accelerate the payment on the loan and reduce the interest costs.
Justin, Konrad, and Merriel
More articles and information are available at www.knowprotectgrow.com
Content Sources: Bloomberg, Trading Economics, Yahoo Finance, BCA Research
Disclaimer: This newsletter is solely the work of Konrad Kopacz and Justin Lim for the private information of their clients. Although the author is a registered Investment Advisor with Echelon Wealth Partners Inc. (“Echelon”) this is not an official publication of Echelon, and the author is not an Echelon research analyst. The views (including any recommendations) expressed in this newsletter are those of the author alone, and they have not been approved by, and are not necessarily those of, Echelon.
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