Today, we will explore a common dilemma for car buyers: whether to buy, finance, or lease a car. We will also evaluate each of these options using some numbers so make sure to read this entire post so you have a better understanding of each option.
Scenario 1: Buy in full
Let’s start with buying a car in full using your own money. The advantage of buying in full is that you own the car outright. If you have the funds available, this can save you a lot of money in interest over time, and you’ll have complete ownership of the vehicle. However, buying in full might not always be the best option for some, as it requires a large upfront payment, which can possibly drain your savings. And especially if you need to preserve that cash for other things, like for emergencies or investments.
Scenario 2: Financing
Now, let’s look at the second option which is to finance your car through a loan. This option will have you make monthly payments over a set period of time. So you basically take out a car loan from a bank or a financial institution to pay for it over time.
This can be a good option if you don’t have all the cash upfront but still want to own the car eventually. Just be mindful of the interest rate and the monthly payments to make sure they fit within your budget. Also, keep in mind that interest rates can vary based on the market and your credit score, which can affect the overall cost.
Scenario 3: Leasing
Lastly, we will evaluate leasing as the third option, which is like renting a car for a set period of time. Just like how you rent a house, when you lease a car, you basically rent it for typically 2 to 4 years. Leasing can be a great option if you want to drive a new car every few years without the hassle of selling or trading in your current one.
However, keep in mind that you won’t own the car at the end of the lease term unless you decide to buy it at the end of the lease term for a set amount of money.
Also, you should consider your mileage needs and any potential penalties for exceeding the agreed-upon limit, as those can add up quickly. So the pros of Leasing are that it requires lower monthly payments compared to financing or buying.
It also allows you to drive a more luxurious vehicle than you might otherwise be able to afford. But as I said you don’t own the car and may face mileage restrictions and additional fees if you exceed that limit. So, If you like long road trips, leasing might not be right for you.
Math-Math baby
Now, Let’s compare the three scenarios using some actual numbers. For example, let’s say the car you want to buy costs $30,000.
Scenario 1: If you decide to buy in full, you’ll have to pay the full $30,000 upfront. You won’t be paying any interest on it, but there is an opportunity cost of it that is you won’t be able to earn any interest if you were to invest that money somewhere else like in a CD or stock market.
So if I need to decide this and the nominal interest rates are low (less than 3%), then buying in full may not be a good idea for me. This is because the opportunity cost of $30,000 is a lot. You could possibly earn a higher return of 7%-8% by investing in a broad-based index fund like these.
Scenario 2: If you finance the car with a loan and a 4% interest rate over 60 months, your monthly payment would be $552. After 60 months, you’ll have paid a total of $33,120. This is greater than $30,000 but spread across 5 years.
Scenario 3: Now, let’s look at leasing. If the lease is for 36 months and you pay $300 per month, the total cost would be $10,800. As you can see, leasing has a lower immediate cost, but you don’t own the car.
Are there any additional costs?
Insurance
Besides the purchase price in Scenario 1, you need to consider insurance, which on average costs around $150 per month. Financing in Scenario 2 demands insurance coverage as well, with no significant difference from the previous scenario. Leasing in Scenario 3 also requires insurance, but it may be slightly higher due to lease requirements.
Maintenance and repairs
Routine maintenance and repairs must be factored in for all scenarios, with an average annual cost of $1,000 to $2,000. In Scenario 1, you have complete control over the quality and cost of maintenance, Financing in Scenario 2 offers no significant difference in terms of maintenance and repair expenses. while leasing in Scenario 3 often includes warranty coverage.
Depreciation
Depreciation plays a significant role in owning a car, with an average yearly depreciation cost of 30%. In Scenario 1, the vehicle’s depreciation impacts you directly, Financing in Scenario 2 shares a similar depreciation impact with ownership. whereas in Scenario 3, the leasing company absorbs this cost.
Resale value
Resale value is another consideration. In Scenario 1, you can sell the car to recoup some costs. In Scenario 2, your car’s value decreases over time, but once the loan is paid off, you have equity in the vehicle. but in Scenario 3, you have no equity. At the end of the lease agreement in Scenario 3, you must return the car, with potentially additional fees for exceeding mileage or wear and tear.
Conclusion
So, when it comes to hidden costs, each scenario has its own factors to consider, such as insurance, maintenance, depreciation, and resale value. Ultimately, you should evaluate which option aligns with your budget, lifestyle, and long-term goals. If you value long-term ownership and have the means to buy in full, it may be your best option. On the other hand, if you prefer lower monthly payments and don’t mind not owning the car, leasing might be more suitable.
Now that you have a better understanding of the pros and cons, hopefully, you can make an informed decision.
