Many cities in the US require cars to commute to work, get kids to school, and go explore. A car is an essential tool in our lives, and I often get asked if it’s a better decision to buy a car or to lease one. Here are some reasons for both.
Purchasing a Car
When you purchase a car and finance it, assuming the interest rate isn’t ridiculously high, I often suggest paying the minimum payment until the car is paid off. The only reason you wouldn’t is if you know you’ll have cash flow issues in the future, and you need to lower your monthly overhead. A car loan is a short-term loan, so the interest rate doesn’t have a significant impact on the total cost of the car; thus, the payments are considered more of a cash flow decision than a cost decision. In general, you’ll likely pay around one monthly payment per year in total interest cost on average. So if your monthly payment is $500, you might expect the annual interest cost to be between $400 and $600, more less, depending on the interest rate.
Here's an example:
Purchase Price: $30,000
Interest Rate: 3%
Loan Term: 60 Months
Monthly Payment: $539.06
Total Aggregate Payments: $32,343.60
Total Cost (Aggregate Payment – Purchase Price): $2,343.60
Total Cost Per Year: $468.60
The average annual cost of carrying the car loan is $468.60, which breaks down to $39.05 per month. This $39.05 monthly cost allows you to utilize the $30,000 purchase price for other purposes. This total cost breaks down to 1.56% of the purchase price. If you utilize the $30,000 elsewhere and more than 1.56% of value is received, you’re better off financing and paying the minimum payment.
Leasing a Car:
Leasing a car is much like renting a house. You’re renting the car, and since the car isn’t yours, you generally have less maintenance worries. When you lease a car, you’ll need to come up with a down payment, followed by a monthly payment. The monthly payment on a lease is generally lower than the loan payment when you purchase a car. This monthly payment is the monthly rental amount, and both the down payment and the monthly payment are determined by the lease contract. The lease contract will provide a maximum monthly mileage allowed on the car, the length of the lease, and a maintenance schedule. The fewer miles you agree to, the lower the payments. If you go over the mileage, you could be assessed an extra charge.
Newer cars tend to have higher resale values, so the shorter the lease, the lower the monthly cost. At the end of the lease, an assessment will be completed, and there will be a purchase price offered to you to purchase the car at a depreciated price. Leasing a car can be a way to borrow a car with the option to buy it.
Why You Should Buy a Car:
- If you prefer to drive a car for a long period of time, purchasing a car will likely provide you the most efficient method for acquiring a vehicle. Whether a car is financed or not, purchasing a car creates a terminal cost, assuming the car is owned beyond the financing period.
- If you go on road trips. Purchasing a car relieves the pressure of mileage limitations.
- If you want to customize your car, you might look to purchase it.
Why You Should Lease a Car:
- If you like driving a new car every couple of years, you can walk away from a car after the lease.
- If you are in a temporary living situation, leasing a car may make sense. If the temporary situation becomes permanent, you can purchase the car after the lease is over.
- If you want less hassle in maintaining the car.
All in all, purchasing a car is generally cheaper than leasing a car if you drive the car for a long period of time. Acquiring a vehicle is a decision based on preference, so there’s certainly no right or wrong choice if the decision is considered carefully. Here is a fun cost calculator if you’re having trouble deciding. Be safe out there!