Many people ask this question when it's time to buy a new car. Questions to ask are the new vehicle being used for business purposes only? Or, will it be the vehicle you use on a daily basis for back and forth to work and errands? Is it a company car being used for my employees? Do I like having a new vehicle every two years? Or, do I want to own a car and then be free of monthly payments?
No matter what your situation, a good idea is to ask your accountant or CPA if leasing a vehicle for business purposes is a good tax expense or not. Beyond that, there are the advantages of monthly payments. They are usually lower, but how does leasing work?
Buying or Financing a Car
We all pretty much know that we can either pay cash for the total amount of a new vehicle at time of purchase or we can finance the vehicle for three to five and even more years at a determined interest rate and when the loan is paid off, we own the vehicle outright. If we finance a vehicle, we also know that we can still trade it in before the loan term on the vehicle is up and have the dealer payoff your vehicle while you begin a loan for a new vehicle.
Buying a vehicle is pretty straight forward. You agree to a price, interest rate, and loan term, and make monthly payments until you own, sell or trade-in your vehicle.
How does Leasing Differ from Buying?
When you think of leasing versus buying a vehicle, look at it this way. A typical car loan is financing the vehicle, where a lease financing the use of the vehicle. When you buy a new car, say the sales price of that car is $ 20,000. By entering into a conventional loan you will pay $ 20,000 plus interest. Once you pay off that loan, you will have paid the entire amount of the sales price plus the interest on the rate you agreed upon.
If you decide to lease that same vehicle for $ 20,000, there is usually no interest rate and instead a monthly tax rate added to your monthly payment as determined by the state you live in. Okay, so the sales price is $ 20,000 for that lease. Every vehicle manufacturer offers leases. Dealerships and financial institutions are given what are called "residual guides" for each vehicle that comes in the form of a percentage. Once the residual percentage is applied to any car lease, it becomes what your monthly payment is really based on.
For example, say that $ 20,000 vehicle's unique brings the amount you are financing or paying your monthly payment on to $ 10,000; or its residual value. Your monthly lease payment is then configured on the $ 10,000 and the interest or tax rate your state requires. Obviously, you can see your monthly payment on a lease at $ 10,000 compared to buying a vehicle at $ 20,000 will be much less. Sometimes, hundreds of dollars less; in a lease you are only paying for a portion of your vehicle's worth.
Other things to consider when leasing are, you usually do not have to make what is called a down payment, but since the vehicle is to be leased, you usually pay the first and last month's payment, plus any dealer or finance company fees and dealers call that "due at lease signing." So telling people no down payment is required is really not true, you will be paying something at "lease signing."
When your lease is up, you usually have three choices; you can buy the vehicle at its residual value ($ 10,000) or refinance the residual value in a conventional car loan, or turn the vehicle in and lease another one.
Why is Leasing So Attractive?
Leasing is attractive for two big reasons, the monthly payment is lower and you can get yourself into a new vehicle if you want as often as every two years. Others may look at leasing a vehicle as a good tax benefit for their company; however, we recommend asking your accountant as lease law obligations change every year.
What are the Downsides of Leasing?
If you lease a vehicle, there are usually mileage restrictions. Say you are on a 24 month lease. You may only be able to rack up 25,000 miles on your vehicle or you'll pay for extra mileage when you turn the vehicle in (unless you buy it). If you travel a lot, leasing may not be for you as mileage costs that are over the set amount at turn in time can be quite expensive.
Summing Up Leasing versus Buying
Leasing versus buying is often a personal choice. Every financial company and manufacturer where you lease the vehicle has different rules and options you must adhere to. These rules include what sort of wear and tear you put on the vehicle during the lease, so ask before you lease. Lease payments are lower per month than conventional auto loans which make leasing attractive.
Buying a vehicle sets your monthly payment and interest rate and you pay that amount every month. A business may still be able to use a conventional auto loan as a tax benefit if they check with an accountant. Tax benefits do not just come with leasing a vehicle. Even if you buy a vehicle with a five-year or 60 month loan term, you can still trade the vehicle in, have the dealer pay off your old loan and get yourself into a new car. With this option though, the dealer will offer you wholesale value for your car and not residual value or even the value you may get online. If you are upside down in your payments, that amount will be rolled into the selling price of that new car you want.
There are many aspects to leasing versus buying a car and before you do either ask the salesperson to compare things like wear and tear, mileage restrictions, interest rates available, and if you will be considered to be upside down if you trade in a vehicle at the time of your decision to lease or buy. Asking the right questions and visiting more than one auto dealer will usually help you make the decision on whether you should lease or buy a vehicle.