Today, at least 25 percent of new cars on the road are leased, not owned. The fastest-growing segment of auto leasing customers is made up of drivers under the age of 35.
While there's plenty of debate over whether worldwide auto ownership has peaked, there is no great mystery as to why younger adults are leasing, according to Edmunds.com With 2015 college graduates averaging just over $35,000 in student debt and the recent average price tag of a new car listed at Kelley Blue Book at $33,543, young adults are looking for options that offer the lowest possible monthly payment.
Indeed, for drivers of all ages, leasing has grown substantially in the past decade because it provides an option to drive with little money down and allows for lower payments than conventional auto loans. This option often results in drivers receiving a newer, higher quality car, that isn't high maintenance, for less money.
How much lower are auto lease payments than loan payments? In 2015, Experian Automotive - a division of the major credit reporting service - reported that those who lease cars versus those who buy cars by loan could save nearly $100 per month. As of second quarter 2015 the average monthly payment for a brand-new leased vehicle was $394 a month against $483 for a new vehicle purchased by loan.
With all of this being said, it would appear that leasing is better than buying, correct? Not so fast.
Leasing may be gaining popularity as an affordability tool, but the decision to buy or lease - or to have a car at all - requires more study, qualified advice and a thorough look at your finances. Let's start with the basic pros and cons.
Pros: Lower down payments and monthly payments than required with a conventional auto loan; low repair costs thanks to factory warranties typically tied to the term of the lease (usually three years); easy drop-off or trade-in once the lease expires; and lower sales tax expense because the lease is based on only three or four years of use.
Cons: You are essentially renting a car, not buying it - payments are cheaper because you are only paying interest and depreciation expense while not receiving any equity in the vehicle; annual mileage caps (usually 12,000-15,000 miles) come with stiff penalties if you exceed those limits; and potentially steep fees for excessive wear-and-tear on the car or early termination of the lease.
Pros: Freedom to put as much or as little mileage, wear-and-tear and modification on the vehicle as you choose; long-term (100,000 miles or over) car ownership with good maintenance can be much more economical long term; and because you own the car, you can sell at any time.
Cons: You'll generally require a higher down payment than a lease; monthly loan payments are generally higher because unlike leasing, you will be taking ownership of the car once it's paid off; once factory warranties expire, you will take on full maintenance costs for an aging car that may or may not be expensive; and you will have more cash tied up in a depreciating asset for as long as you own the car.
All these positives and negatives aside, it is important to understand that with loans and leases most details are negotiable, so it's important to do your research. Start by estimating how much car you can actually afford and seek out qualified financial and tax advice to shape how you'll approach the best possible deal for your financial situation.
For many, leasing requires more extensive study because this form of financing is relatively new to most drivers and the terminology can be daunting. But generally, the best deals depend on two factors - negotiating the lowest price on the vehicle going in and making sure it's a vehicle that has a high estimated post-lease value.
Here's why. The actual negotiated price of the vehicle helps determine your monthly payment. So no matter what financing deal you're making, lease or loan, you need to get that number as low as possible. However, in a lease deal, there is another major issue that influences a customer's monthly payment and it's called residual value. Lessors want to make sure they can still keep making money off your car once the lease is up, and they know they'll have a better chance of doing that if your model has a reputation for holding its value long-term. That long-term value makes it easier for lessors to offer lower monthly payments going in. It's actually the reason why you see so many people driving high-end cars with long-term value who otherwise couldn't afford to buy such top luxury brands.
However, don't think this means you should start looking at cars outside of your budget range. Keep in mind that this formula also applies to leasing mid- and lower-price automobiles as well.
Other chores to add to your leasing vs. buying checklist:
Check your credit. One other thing that doesn't really change for drivers who choose to borrow or lease - you're going to need good credit to make the best deal. Before you start shopping, review your three free credit reports for accuracy and check your credit scores in advance.
Investigate insurance options in advance. Before you make a lease or loan deal, call your insurance agent. In general, some models cost more to insure than others, and that might affect what you buy. But when any form of financing is involved, there is an added financial risk. Consider investigating "gap" coverage that would pay the difference between the actual cash value of a vehicle and the balance still owed if your car is totaled.
Bottom line: Car leasing is a growing affordability option for drivers, but like renting or owning a house, there are important distinctions in getting the right deal on a lease versus a loan. Making the right decision requires good research and a close look at your finances.
Nathaniel Sillin directs Visa's financial education programs. To follow Practical Money Skills on Twitter: www.twitter.com/PracticalMoney
This article is intended to provide general information and should not be considered legal, tax or financial advice. It's always a good idea to consult a legal, tax or financial advisor for specific information on how certain laws apply to you and about your individual financial situation.