Every day we make choices based on personal preferences: coffee or tea, boxers or shorts, etc.
However, some financial decisions are not so unambiguous. After all, we can’t make spending decisions based on preference alone. If we did, we could live in luxury for a while before going bankrupt.
An obvious, often misunderstood example is buying or renting a car. The decision to buy or rent a car seems to be one of preference: would you rather always drive a new car for a relatively small monthly fee, or finance a car that you will someday fully own?
Of course, we have to remind you that financially the best way to buy a car is to pay cash for something used so you don’t have to pay both interest and sudden depreciation.
However, many people are unable to pay cash for their cars and car loans are the only way they can afford it. By contrast, a lease allows you to drive a car for a fixed period of time (often three years) by making monthly payments until the car lease expires.
Why rent is so tempting
“Probably the biggest benefit of leasing is the lower fees,” says Jerry Love, a member of the CPA National Commission on Financial Literacy.
“If you only plan on owning the car for a few years—say, three years at the most—then leasing allows you to pay less and you don’t have to worry about the value of the car being put up for sale.”
The last consideration is important because new cars depreciate the moment you roll them off the assembly line. And while leasing allows you to get a new car every few years, those who buy a new car are likely to keep it for much longer, its value falling every year until it’s time to trade in. Allison Baumeister, Fellow of the Texas Society of Certified Public Accountants, says:
“The initial cost of buying is higher than leasing; this includes a down payment as well as a higher monthly payment.”
For someone on a budget, it’s easy to see why leasing is so tempting: you get a brand new car and a monthly payment that’s lower than a car loan.
But rent is the devil in disguise.
First, the rental has a mileage limit where you will be penalized if you exceed a set amount; these fines can range from $0.05 to $0.20 per mile. It is important to determine in advance how you will use the car (short or long distance) and what the mileage limits are. The 40,000 mile limit will give you more wiggle room than 30,000, but you’ll pay extra up front.
Moreover, leasing allows for normal wear and tear on the car, but “if the dealership finds that… the car has a higher wear [normal] at the end of the lease, they may charge you extra,” says Love. You can get a better idea of what “normal wear and tear” means by interviewing a car dealership and looking into the terms of a lease.
Read more: Car Availability Calculator: How many cars can I afford?
Why is it better to buy
Love points out that if a dealership offers 0% financing and you plan to drive the car for a long time, buying is the way to go. If the funding conditions are higher,
“Often credit unions will have a favorable rate. And if you have an established relationship with the bank, you should definitely check with them about their rate.”
Another member of the Financial Literacy Commission, Claire Levison, points out that car payments will eventually stop, while lease payments won’t stop until you turn the car in.
“When you buy, you will end up paying for the car and no longer paying monthly rental payments.”
Regardless, “when you rent a car, you pay for a set period of time and then at the end of the period you have nothing to show for your money,” says Baumeister.
“You have nothing. However, when you buy a car, it becomes your property at the end of the term. You can keep this car indefinitely or sell it for a price.”
Read more: How to finance a car wisely
An example of comparing the cost of buying and renting
Let’s see how much it can cost buy or rent a new car. You’re considering a 2023 Kia Soul, a reliable SUV with a generous warranty and cargo space.
First, you think about buying. The starting MSRP for this vehicle is $19,890. So if you go for the most basic trim, the LX, without any tweaks, you’ll be spending roughly $20,000 on how many years you want to spend to pay off your loan.
Many people choose the six-year or 72-month option, and it might work for you too. If you make a down payment of $3,000 and get approved for a 5% interest rate with a 6% sales tax rate, you’ll pay $23,778 to buy the car, or a total of $3,963 per year. The loan will be repaid in six years.
Now let’s talk about rent. The same car, but instead of renting for 72 months, you enter into a lease for 36 months. This requires a $300 security deposit and a $250 monthly payment. During the three years of the lease, you will spend $3,550 annually on your car. And if you renew your lease for another three years, for a total of six, you’ll spend a total of $21,300.
As you can see, leasing Maybe be cheaper. In this case, leasing will cost a couple of thousand cheaper than buying the same car. But while leasing may technically cost less in many cases, this example doesn’t take into account the fact that when you buy a car, it becomes your owner. When you rent a car, you borrow it. Renting is a costly liability, not an asset.
So yes, you may very well end up spending more money when buying a car, but you can get a good deal of that money back if you decide to sell it even with depreciation. And of course, you can choose the best rates when applying for a new loan, or even refinance your car loan to save on interest.
Read more: Best car loan rates in 2023
Is leasing a reasonable option?
Here’s the hard truth: For most people, leasing doesn’t make financial sense. “Buying a car is almost always better than renting one,” Baumeister emphasizes.
There are some exemptions for business owners or others who can deduct certain vehicle expenses. For everyone else, renting a car should be considered a luxury.
Rent a car if you just love driving a new car every three years and the cost is worth it. As long as you’re aware, it’s okay to make a conscious decision to spend more on your cars than you might need.
Summary
Why is it so much more profitable to buy?
In addition to the advantage of owning an asset even if it has depreciated, there are other monetary variables that need to be considered. Baumeister says:
“The cost of annual auto insurance for a rented car is usually higher than for a purchased car. Also, the driver of a rented car must pay personal income tax for the car. Some states do not charge personal property tax on the vehicle you purchase. This tax is often stated in fine print on a car rental agreement.”
No matter which option you choose, go shopping. Especially when buying: “The exact price of a car can vary greatly within your region of the country,” says Love.
“The terms of the lease or the terms of the note can also vary greatly. Do some research to determine your expected price and then go to a dealership that has the information.”