Your Next Car: Should You Buy Or Lease?

This Financial Guide gives you a framework for deciding whether leasing a car makes sense for you. It explains the meaning of various lease provisions, as well as the initial, ongoing and final costs of leasing. Finally, it gives you the information you need to negotiate the best possible lease.

How Leasing Works

There are two types of lease arrangements: closed-end ("walk-away") and open-end (finance). Here's how they work:
Closed-End Leases: The Dealer Bears the Risk Of Depreciated Value
When a closed-end lease is up, you bring the car back to the dealership and "walk away." the car must be returned with only normal wear and tear, and at or less than the mileage limit stated in your lease. Since the dealer, and not you, is bearing the risk that the value of the car at the end of the lease will go down, your monthly payment is generally higher than with an open-end lease.
Open-End Leases: You Bear the Risk of Depreciated Value
With an open-end lease, you bear the risk that the car will have a certain value, called the estimated residual value, at the end of the lease. In this case, the monthly payment is lower.
When you return the car at the end of the lease, the dealer will have the car appraised. If the car's appraised value is equal to the estimated residual value in the agreement, you won't need to pay anything at the end of the lease term. Under some contracts, you can even receive a refund if the appraised value is greater than the residual. If the appraised value is less than the residual value, however, you may have to pay all or part of the difference.

Tip: If you disagree with the value arrived at by the appraiser, you may choose to have an independent appraisal made at your own expense, and then try to negotiate an agreement with the dealer as to the residual value. Try calling other dealerships to find an independent appraiser or a vehicle appraisal service.

Option Rights

Your option rights include the right to (1) purchase, (2) extend or renew, and (3) early termination.
Purchase Option. Your lease may include the option to purchase the car at the end of the lease term. This option is usually found in open-end rather than closed-end leases. Under the CLA, the dealer must tell you the estimated residual value of the car and the formula that will be used to determine your purchase price at the end of the lease.

Tip: If you think you might want to buy the car, be sure the purchase option is in your lease before you sign it; otherwise you'll have to renegotiate later, at which time you may have less bargaining power.

Renewal Option. You should negotiate the right to extend or renew as part of your lease. Sometimes the lessor will reduce your cost if he knows you might want an extension of the contract.
Early Termination Option. If you terminate your lease after, say, 36 months on a 48-month lease, you will have to pay an extra charge, based on the difference between the residual value of the car at that time and the estimated residual value at the end of the lease term (stated in the contract). The difference between these two may be great. In most lease agreements, you must keep the car at least 12 months.
The CLA requires that the dealer tell you before you sign the contract whether you can terminate early, and the cost of early termination.

Tip: Look for a premature termination clause, which provides for termination prior to the end of the lease term.

Other Factors to Consider

There are a number of other factors that come into play in the lease-vs.-buy analysis:

• When you buy a car, every monthly payment increases your equity. You'll end up with a car (of depreciated value) you can either sell or keep. In leasing you get no equity; the monthly payment is more like paying rent. You don't own the car at the end of the lease though you may have the option to buy if that is included in your lease agreement.

Tip: With leasing, you can invest the money you would have used for the down payment. If you use the car for business, whether you lease or buy, you can deduct some or all of the cost of the car subject to current IRS rules.

• Because they aren't considered "debt", leasing contracts typically aren't listed on a loan application; leaving your credit free for other loans.
• Leasing a car is convenient and frees up cash you wouldn't have available if you bought a car since the initial costs can be lower.