Should I Lease or Buy a Car?

While there are some cities in the US where owning a car isn’t essential to getting around, most people find the need to have a vehicle for transportation. Sitting through an episode of your favorite television show will expose you to at least a few car commercials with offers for either leasing or buying. Once you have done your due diligence to research what type of car is right for you, the decision to lease or buy shouldn’t be taken lightly.

If you decide to purchase a car, you will most likely need to take out a vehicle loan, which typically runs from 4 to 6 years. As with most loans, you will have need to have a down payment.  Your payments will be calculated based on your down payment and interest rate (in which you credit score will be a factor). Once you pay your vehicle loan off, the car is yours and you can continue to drive it without the monthly payment weighing on your budget and you can sell your car. Owning a car will also tend to save on insurance premiums.

Leasing a car is essentially borrowing a car from the dealership for a certain period of time. When you lease a car it usually doesn’t require a down payment and if it does, it’s relatively small. Lease payments also tend to be relatively smaller than a payment would be towards owning the same car. However, lease payments do not go towards your ownership of a vehicle. As long as you are driving leased cars, you will have a payment. Leased vehicles usually come with a yearly mileage limit - typically 12,000-15,000 miles a year - and a monetary penalty for every mile driven over the agreed upon limit. A close inspection is usually done upon the return of the vehicle. A penalty may be assessed for stains, wear and tear, or other cosmetic imperfections beyond normal wear and tear.

The decision whether to purchase or lease is a complicated one. As Consumer Reports notes, “The financial workings of leasing are so confusing that people don’t realize that leasing invariably costs more than an equivalent loan. And even if they did, the extra cost is difficult to calculate.” Similarly, according to Bankrate.com, experts say “buying and keeping a new car for the long term is usually the better deal.”

But why might you lease? First, do you plan to keep the car for 3 years or less? Second, are you planning to drive fewer than 12,000 - 15,000 miles per year (depending on the lease agreement)? Third, will you be able to avoid minor damage or cosmetic defects? (Any parent knows that spills happen when you’re carting around small children!) If you answer “yes” to ALL of these questions, then are you usually better off leasing -- otherwise, purchase. However, even if leasing seems appealing, really ask yourself why you feel the need to change your car so frequently. Is having the newest car really worth it?

Another reason for leasing is if you are a small business owners. You can sometimes reap the reward of tax deductions for lease payments if the vehicle is primarily used for business.

As with any commitment, be sure you diligently research your options and shop around for the best prices, contract terms and interest rates to save yourself money. Be sure to read ANY (lease or sale) contract closely, watching out for any fine print and noting any parameters that you need to abide by to avoid any surprises in the future. Happy driving!

 

Kent Smetters

Kent Smetters is the Boettner Chair Professor at The Wharton School of the University of Pennsylvania, the Interim Faculty Director of the Penn Wharton Public Policy Initiative, and a Faculty Research Fellow at the NBER. He was the former Deputy Assistant Secretary of the U.S. Department of the Treasury, and he subsequently served as a member of the U.S. Congress’ bipartisan Blue Ribbon Advisory Panel on Dynamic Scoring. Kent holds bachelor degrees in Economics and Computer Science from The Ohio State University as well as an MA and PhD in Economics from Harvard University. He previously cofounded a national registered investment advisory firm that built a new technology platform, grew the firm to over 50 advisors and then sold the firm to a large, publicly-traded company. Growing up in a financially poor family, Kent donates his time to “Your Money” to help families work, save and set goals in order to achieve the most in life. Kent is often cited in major news outlets.

How Much Car Can I Afford?

Automobiles are often seen as a status symbol and if you believe all of the advertisements that seen to be everywhere, you can drive the top of the vehicle for a minimum monthly payment. With incentives like low payments and zero interest, it is often easy to forget that you need to analyze how much you can truly afford before driving off of the sales lot.

In order to decide how much you can afford on a car payment, you first should look at how much money you have to put down. Try to put at least 20% down on a vehicle purchase. While this might seem like a lot of money to put down, it will help you in three ways: it lower your interest rates, lower the amount of money borrowed that will affect your credit score, and also keep your payments lower. Saving up the 20% may seem daunting, but it is the first step in being able to set a the goal of purchasing a realistic vehicle.

Next, you should look at your household gross (before taxes) monthly income. Your car payments should be no more than 10% of your monthly income. Keeping your car payments as close as possible to 10% will help your monthly budget stay on track. You also should not finance the car for more than four years. Car dealers will often offer to extend car loans for up to seven years to make a vehicle seem more affordable- however, vehicles depreciate and with a loan longer than four years, you will soon owe a significant amount more than your car is worth.

With these simple steps in mind, it is also important to remember that car sales is a competitive field, as are loans. When shopping for a car, remember to compare prices and offers from several dealers. Also, shop around different banks for loans: don’t just take the deal offered by the car dealer. Likewise, shop around for car insurance quotes. By paring some keen negotiation skills with a budget conscious price range, you will soon be driving a car that is well within your means.

Kent Smetters

Kent Smetters is the Boettner Chair Professor at The Wharton School of the University of Pennsylvania, the Interim Faculty Director of the Penn Wharton Public Policy Initiative, and a Faculty Research Fellow at the NBER. He was the former Deputy Assistant Secretary of the U.S. Department of the Treasury, and he subsequently served as a member of the U.S. Congress’ bipartisan Blue Ribbon Advisory Panel on Dynamic Scoring. Kent holds bachelor degrees in Economics and Computer Science from The Ohio State University as well as an MA and PhD in Economics from Harvard University. He previously cofounded a national registered investment advisory firm that built a new technology platform, grew the firm to over 50 advisors and then sold the firm to a large, publicly-traded company. Growing up in a financially poor family, Kent donates his time to “Your Money” to help families work, save and set goals in order to achieve the most in life. Kent is often cited in major news outlets.