Finance Q&A

Should you lease your next car or buy it with a loan? The answer depends on how long you plan to drive the car, the resale value of the car you want, how often you want a new car, how much monthly payments will be, or how much it will cost each year to drive the car.

Leases and purchase loans are simply two different methods of automobile financing (leasing is NOT renting). One finances the use of a vehicle; the other finances the purchase of a vehicle. Each has its own benefits and drawbacks. This Q&A section provides some of the answers, and the finance specialists at Mike Miller Auto Park in Peoria can answer any other questions you may have and help determine what is best for you.

Are monthly payments necessary?

Unless you are able to pay cash for a new or pre-owned vehicle, you'll need to establish a payment plan to obtain that vehicle. Two options exist - a traditional loan or leasing.

How do loans and leases differ?

When you choose a loan, all payments apply to your eventual ownership of the vehicle. The initial down payment and principal on the loan cover the total cost of the purchase. Lease payments, however, apply only to the use of the vehicle. The total sum of payments covers the vehicle's depreciation over the time you drive it and is usually less than the outright price of the vehicle.

When is ownership transferred?

When you sign a loan the finance institution holds a security interest or lein against the title of the vehicle. When paid in full, a loan terminates and you assume ownership. Your financial institution  sends you the title that had been held while the loan maintained an outstanding balance. When a lease period ends you return the vehicle to the lessor, unless the lessor offers to sell the vehicle afterwards. During the entire lease period the lessor maintains ownership and simply allows you to use the car. Ownership is only transferred if you choose to buy the vehicle after the lease terminates.

How are monthly lease rates determined?

In formulating a monthly payment structure, a lessor is primarily concerned with the extent to which the vehicle will depreciate throughout the lease and the cost of borrowing money to finance the car during that period.

Three key elements:

  • First, the adjusted capitalized cost is determined. This figure represents the real purchase price after elements such as the down payment, incentive discount and trade-in credit are deducted from the capitalized (actual) cost, while any fees or charges (e.g. destination) are added.
  • Second, the residual value, or estimated value of the vehicle at the end of the lease, is determined and then subtracted from the adjusted capitalized cost to yield a depreciation figure. The residual value depends on the length of the agreement, expected mileage and make/model of the vehicle.
  • Finally, a lessor assesses the money factor, a number that correlates with the cost of borrowing money during the lease period.

While these terms may seem unfamiliar, the Federal Reserve Board now requires dealers to publicize all leases' down payment amounts, lengths, residual values and interest rates.

What factors determine the purchase price at the end of a lease?

Most leases rely exclusively on the residual value in determining the end-of-term purchase price. These closed-end deals require you to pay the fixed residual amount regardless of the actual market price. Open-end leases work differently in that the actual market value helps determine the purchase price. As a customer, you are responsible for any difference between the residual and actual value when buying outright.

How are loan rates determined?

The loan payment depends on the amount borrowed, the length of the loan, the interest rate and other factors, such as your credit history. Paying more money initially lowers the principal of the loan, thus reducing individual payments. At any period during the loan, you may opt to pay off the principal in its entirety, at which point the title of the vehicle is transferred to you.

General loan specifications:

  • Down payment amounts may range between 10 to 20 percent of the vehicle's total cost, although some purchases require no down payment.
  • A typical loan period is five years with an annual percentage rate around 8 percent.
  • Some manufacturers offer lower rates, but be sure to investigate any associated conditions or clauses.

Are loans available for used vehicles?

Yes, although they function somewhat differently from new car loans. A down payment of 20 percent or more is often required and the interest rate can be a point or two higher. Understandably, banks are more hesitant to loan money for used car purchases, as they would rather own a newer car if the borrower defaults. However, the market is full of good used vehicles, many of which are created by short term leasing.

Can extra fees and charges be financed?

Yes, registration, taxes, extended service plans and other supplemental charges may be included in the financing plan.

Which option makes the most sense?

The answer to this question depends on how you plan to use the vehicle. If you like the idea of driving a more expensive vehicle for a lower monthly payment, leasing is a great option. However, if eventually owning the car is important, financing with a loan is the way to go.

What are the restrictions of driving a leased vehicle?

Annual mileage restrictions are a major limitation for customers who choose to lease. Lessors want their vehicles returned in saleable low-mileage conditions, so they place mileage caps on them. A typical yearly figure is between 12,000 and 15,000 miles. Beyond the established limit, fees accrue on a per-mileage basis, usually in the range of 10 to 25 cents per mile. So, if most of your driving is local, leasing makes sense. However, if you consistently tack on 500 or more miles a week, definitely look into a loan.

What are the other virtues of a loan?

Loans are also sensible for those who want to customize their vehicles, plan on keeping their cars for long periods of time and plan to re-sell their vehicles to help recoup the costs of ownership or expenses of additional cars. For those who quickly wear vehicles out, loans may be safer bets as lessors often add "excessive wear" charges if the car is returned with wear over the limits established by the contract.

Why lease?

Leasing ensures that you'll always drive a late-model vehicle, won't have to pay for warranty-covered repairs and won't have to bother with re-selling at the end.