Does it make sense for you to finance your vehicle or to lease it? Both come with their own unique sets of pros and cons. And although money obviously plays a role in your decision, it’s not the only factor. Lifestyle and personal preference also have a bearning on which route you choose.
Here’s a simple guide to leasing and buying to help you decide what makes sense when shopping for your next vehicle.
When you lease a vehicle, you’re paying for the amount of the vehicle that depreciates over the term of the lease. In other words, you’re paying for the total value of the car that you’ll be using.
And the amount of the car value you don’t use? That’s called the residual value.
Both depreciation and residual value are connected in determining a lease payment.
Let’s say the selling price of the car or truck you want to lease is $40,000. At the end of a three-year term, according to historical research done by the leasing company concerning the make and model, the vehicle is projected to be valued at $22,000. That’s the residual value.
Now, take the selling price ($40,000) and subtract the residual value ($22,000) to calculate the forecasted depreciation, which is $18,000.
In this case, your lease payments are used to cover that $18,000 (plus applicable interest) in depreciation over monthly or bi-monthly payments across the term of the lease.
For this example, the lease on a $40,000 vehicle at 1.9% over three years will cost approximately $620 a month, not including registration fees, deposits and a down payment (according to the Canadian Government Lease or Buy Calculator).
Leases are typically offered in terms between 36 to 48 months (three to four years), but can be shorter or longer. Lower kilometre leases are usually associated with lower payments because the vehicle is driven less, which reduces the amount of depreciation.
And if you love the vehicle, you can opt to buy it out at the end of the term.
When you buy your vehicle, you pay for its entire cost and gain an asset at the end. Adepreciating asset, yes. But you own the vehicle outright.
Unless you can pay for the vehicle with cash, you’ll have to finance the purchase of your vehicle. To do that, you calculate the selling price, down payment, taxes and registration fees and finance the entire cost through a loan with an interest rate determined by a lender. The interest rate you pay depends on your financial situation and credit score – those with the highest scores are most likely to take advantage of interest rates as low as 0%.
Once you secure financing, you make monthly payments over the agreed term of the loan until the term is finished and then the car belongs to you.
You may choose to sell or trade in the vehicle for its depreciated value, or, hold on to it and enjoy not having a monthly car payment.
If you take the same $40,000 car from the lease example, add the sales tax and secure a finance rate of 1.9% over five years, your monthly payment would be $790.28 exclusive of registration fees, deposits and a down payment. Yes, the payments are higher but there’s a reason why financing is a popular option.
Monthly payments aside, there are benefits and drawbacks to both leasing and buying. Here are some factors you should consider when making the decision to lease or buy.
Pro: Usually a lower monthly payment than a loan and you only pay for the portion of the vehicle you use – the depreciation.
Pro: Allows you to drive a new car every few years without paying as much.
Pro: The leased vehicle’s warranty usually applies for the duration of the lease.
Con: You don’t own the vehicle and if the lease terms aren’t met, it can be costly.
Pro: No kilometre restrictions – drive it as much or as little as you want.
Pro: You own the vehicle and can use it as a trade-in on the next one you buy.
Pro: Buying a car or truck is more beneficial for people who plan on owning it for many years.
Pro: You’re free to modify your vehicle any way you like.
Con: Higher monthly payments and longer payment terms than a lease.
If you’re looking to drive a new car every few years and can confidently stay within the lease terms, leasing might be right for you. If you don’t want any restrictions and plan on holding onto your vehicle for a longer period of time, then financing might be your best option.
In the end, doing your research and better still, speaking to a Northern Advisor, will help you make an informed decision and determine whether leasing or buying suits your life and overall financial health.