Cash, finance or lease: What’s the best way to pay for a new vehicle?
The question comes up regularly. On this topic, many have an opinion. Unfortunately, not all those opinions are based on current facts.
Since 93 per cent of all new vehicle sales are not cash, let’s focus on whether we should finance or lease a vehicle. It’s important to understand that they are both just different ways to pay for the same thing. There is no universal right or wrong way to do this. Don’t rule out one or the other until you understand both and have compared them to your personal circumstances. (As an aside, please keep in mind there are almost no good reasons for using a line of credit to acquire a vehicle. People do it and only pay the interest, like a credit card, because they can. As the vehicle depreciates they are not paying down the loan. Disaster looms.)
When we finance the purchase a vehicle, we are committing to a loan for the total cost of the vehicle along with all fees, taxes and interest charges, less any down payment or trade equity. We agree to make all the payments until the vehicle is completely paid off or we successfully trade or sell it and pay off the balance. Financing terms are generally between 48 and 84 months although longer terms have become available in recent years. These terms have increased as people looked for lower payments on more expensive vehicles.
When we lease, we are committing to make payments on the vehicle from the selling price to an agreed upon future value or buy-out. This is sometimes also called a residual or guaranteed future value (GFV). It includes any fees and interest charges during the term. At the end of the lease we have this buy-out option or GFV on the vehicle, leaving us a choice to make. We can keep the vehicle and buy it out for the GFV (plus tax), trade in the vehicle, or simply walk away. Lease terms are usually between 24 and 48 months although 60 month leases have become available in recent years.
So which is better? It depends on your personal situation, needs and driving habits. The smartest thing is to match your financing cycle to your trading cycle. Some things to consider: if you are between the ages of 25 and 55, you are in a stage of life where big changes occur: jobs, family, income and so on. These changes can affect the type and size of vehicle you need, as well as its capabilities, price and the distance you travel in it. People beyond this age range often drive far less and have fewer needs changes in their lives. When you drive more you usually need to trade more often.
The downside to financing is that it usually requires a higher down payment to ensure you can trade the vehicle in early and avoid owing more than it’s worth. You are committed to making payments for the full term of the loan. Monthly payments are usually higher than lease payments on the same vehicle. And once your warranty expires you are responsible for all repair costs.
Leasing allows you to shorten your trading cycle and is a better choice if you like to drive a newer, fancier vehicle with a lower payment. With the GFV at the end of the term, you have three choices. At the end of the term, if the current market value is higher than the GFV, you could choose to sell or trade the vehicle and take advantage of the equity or simply buy it out for the GFV plus tax. If the current market value of the vehicle is lower than the GFV, you could simply walk away. If having a predicable cost of driving is important to you, then leasing is a good choice. There may be a business tax benefit to leasing as well, but discuss that with your accountant to be sure.
The downside to leasing is that your mileage is generally limited to however many kilometres you set it up for at the beginning. Purchasing additional kilometres in a lease can make the payment substantially higher. If you have an unexpected increase in mileage, leasing can become very costly. Excessive wear and tear or damage must be paid for before the lease’s end if you’re not going to keep the vehicle. On the other hand, the vehicle does not know whether it was financed or leased. Excess mileage and wear and tear can lower the value of the vehicle either way. People unfamiliar with lease contracts can find them confusing. The structure of leases in the distant past sometimes left people owing large sums at the end. This put a negative connotation on leasing.
Most dealerships will offer you a side-by-side comparison of purchase financing and the short-term trade cycle or leasing. Sit down with a car person you trust and go over your personal situation and what you think your needs will be over the short, medium, and long term. Try to find a nice balance between your wants and needs. Again, try and match your financing cycle to your trading cycle. Working together you should be able to determine what’s best for you.