Just as some people prefer to live in apartments or condos instead of buying houses, many people are choosing to lease their new cars, rather than buying them outright. For some, this is a decision influenced by credit scores - typically, low credit scores get you more money with a lease - but it's a lifestyle choice as well: if you prefer driving newer vehicles, and if you don't mind always having a car payment, leasing can be beneficial. Alternatively, if your ultimate goal is payment-free reliable transportation, or you're in the market for a used car, an outright purchase is probably your better bet.
When you purchase a car, you typically make a down payment, and either pay fees and taxes in cash or roll them into your loan. You pay interest at a rate determined by your lender, and your monthly payments begin a month after your contract is signed. Your loan payments go toward the vehicle's entire cost.
When you lease a car, though, your payments are only going toward the part of the vehicle's cost that you will use in the time you have it. In addition, you have the option of not making a down payment, and, in most states you pay sales tax only on your monthly payments, which include a money factor that is not unlike the interest rate on a loan. In addition, there may also be additional fees, or even a security deposit, and your first payment is made when your sign your contract.
As an example, if you purchase a car that costs $25,000 you pay all of it, plus taxes, fees, and finance charges, but because cars begin to depreciate the moment they leave the lot, 24 months later, that car may only be worth $15,000 if you were to resell it.
If you lease the same $25,000 car, it will still depreciate at the same rate, but instead of paying the entire cost, you only pay for the difference - the part you use - of $10,000 (plus finance charges and fees). This is why leasing is generally less expensive than buying.
Loan payments are made of two parts, principal, which represents a portion of the entire cost of the vehicle, and the finance charge, which represents the interest charged by your lender. Think of interest as the fee you pay for borrowing money.
Lease payments are also composed of two parts, a depreciation charge, which compensates the dealer or leasing company for value lost during the lease (again, it's the part of the car value that you are using) and a finance charge, which is interest charged for the lease company's investment in your car.
The obvious difference between purchasing and leasing a vehicle is this: at the end of the loan term, you own the car, but at the end of a lease, you have to either return the car, and lease another, or buy out the remaining balance of the car's value (also known as equity). One of the benefits of leasing, however, is something called gap insurance. Gap insurance, which you pay for, insures the difference between the value of the car, and what you owe on your lease, which can be extremely beneficial in the event of a serious accident that results in above-average damage to the vehicle.
Because of depreciation, if you are buying your car, you may find yourself in the position of owing more on the loan than the car is actually worth, and while gap insurance can, in theory, be purchased separately, it's extremely difficult to find an agent who sells it.
With the obvious benefits of smaller monthly payments and gap insurance, it may seem that leasing is the perfect choice for everyone, but that isn't necessarily true.
Certainly you should consider a lease if the car you want is more expensive than you can easily afford (more than about $30,000), or if you have slightly dented credit, or limited cash for a down payment. Leasing is also an excellent choice if you prefer to have a new car every three or four years, but remember that when you lease, your car payment is with you forever. Also, if you frequently drive more than 15,000 miles a year, leasing can cost you money, as excessive mileage incurs extra fees when the lease is over.
Damage, too, costs extra when you turn in a leased vehicle - anything over and above 'normal' wear and tear can incur fees.
Buying, on the other hand, is a better choice if you want reliable transportation without a car payment, or if you're considering the purchase of a used car. Since most of the depreciation occurs in the first few years after a car is built, leasing a used car may not save you money. And just as extra mileage costs money when you lease, if you frequently make long trips, purchasing your car may be the way to go.
Fundamentally, just like choosing a house in the suburbs, or an apartment in the heart of a city, the decision to lease or buy is a lifestyle choice. Whichever you decide, however, make sure that you get quotes from more than one lender or lease company, and read all the fine print before you sign.