If you’re in the market for a car, you might be toggling back and forth between buying and leasing.
It’s not an easy choice to make, especially with interest rates at historic highs and life feeling so precarious. The choices you make now might take a heavier toll, a much deeper impact on your future and your credit.
So, if you’re planning on taking on debt right now, it’s crucial to know enough to ensure you don’t dig the kind of hole you can’t get out of later.
It’s important to understand that while leasing or getting a loan for buying a car is similar to getting a mortgage loan, there are some key differences.
Down payments and car loans
If you don’t have enough in your savings to pay the full sticker price of a car (plus taxes) up front, seeking a loan is something you might’ve already considered.
In Canada, there are no regulations that dictate the minimum initial payment required for a financed car purchase or lease. Some dealerships will even offer you a zero-down agreement.
This is different than with mortgages, which always require at least a 5% down payment because of government regulations.
With cars, it’s typical to see down payments of 10 to 20%, but according to a report by Edmunds, most people make down payments in the lower end, averaging 11.7%.
A larger down payment will get you better financing options for your car loan. This is similar to when you get a mortgage, where larger down payments (up to 20%) help reduce interest rates. Larger down payments also reduce your scheduled payments – since you’re getting a smaller loan, a better rate, and paying less interest overall.
For example*, let’s say you live in Ontario and wanted to finance the purchase of a brand new 2022 Toyota Corolla LE (without any fancy add-ons) for three years (or 36 months). This car has a finance vehicle price of approximately $27,200.
Using the dealership’s calculator, we can see that with a down payment of $0, they could offer you a rate of 4.09% and you would pay $805 per month.
With a 10% down payment, the interest rate offered is the same, but your borrowed amount goes down to approximately $24,500, and your monthly payments decrease to $725 per month.
With a down payment of 20%, your borrowing amount goes down to approximately $21,800, and your monthly payments are reduced to $644.
Essentially, the more money you put up front, the lower your monthly payments will be. Also, keep in mind that it’s possible to negotiate, and to get a better interest rate with a higher down payment.
Car loans and the lenders
Unlike with a mortgage, though, your financing is more likely to be handled directly through the car retailer or dealership, instead of through a financial institution.
You can always go directly to a bank or credit union for a loan – and you might have to if you’re hoping to buy the car from a private seller.
But most dealerships have their own business managers who work similarly to brokers.
These business managers have long-standing relationships with financial institutions. Most of the time, they will be able to get you a better interest rate than if you are dealing with the lender directly.
Keep in mind, though, that it’s their job to sell and to get you to borrow directly through the dealership.
In Canada there is no minimum credit score legally required for a car loan, so even if you have less-than-stellar credit, many dealers will try to make a sale.
This might not always be in your best interest. So, it’s always a good idea to shop around – just like with a mortgage – before deciding on the best lending option.
Just like brokers, business managers calculate what risk you present to the dealership then determine what rate they can offer you based on your credit score, the relationships they have with lenders, and how long the term of your loan/lease is.
Remember, though, getting a lease or a finance loan is never guaranteed. If your credit score is too low, many dealerships will not be able to arrange a lease or finance deal for you.
If you have bad credit and decide to borrow from a private lender, you will have to pay a much higher interest rate.
In most cases, the lower your credit score, the higher the interest rate you will be offered.
The good news is that even if you get a high interest rate, you can refinance once your car loan helps you build up your credit score.
Another thing to keep in mind is that unlike with a mortgage, the interest rate a dealership offers you is always fixed for the term of your loan. So if interest rates go up or down, your car payments won’t be affected.
The pros and cons of buying a car
One of the biggest incentives of buying rather than leasing a car is that when you’re done paying your loan the car is yours. In this regard, buying a car is similar to getting a mortgage – once you pay off your loan, it is an asset. It’s yours to do with as you please: sell, keep, or give away.
But buying comes with some downsides. For example, you will face larger upfront costs for the down payment (although some dealerships offer “zero-down” options), larger scheduled payments (when compared to leasing the same car), and paying for the depreciation of your vehicle upfront.
What about leasing a car?
Leasing a car is much like renting a home. You are essentially borrowing someone else’s property and paying them a monthly fee for the benefit. But you have the option to buy at the end of the term, for a set lump-sum payment.
When you lease a car, you also need to consider that you’re paying interest directly to your lender, which is not something you need to do when you rent a property. This rate is determined by your credit score and the length of your lease, among other things.
This type of arrangement is usually ideal for people who like to upgrade their car often, who don’t want to commit long term to owning any vehicle, or who want to make lower payments in the short term.
When it comes to your credit, the only real difference between whether you lease or buy is the amount showing up on your credit report. With a loan, the whole purchase price of the car will show on the report. With a lease, your owing amount is smaller, since you’re borrowing only a “portion” of the vehicle’s life and value. On your report, your lease amount will show up as the purchase price of the vehicle minus the residual value at the end of the lease.
Since your borrowing amount is smaller with a lease, your monthly payments will also be lower than if you were to purchase the same vehicle.
What’s better, owning or leasing a car?
Let’s say you live in Ontario and want to lease a brand new 2022 Toyota Corolla LE (base model) for three years (or 36 months)*.
With a dealership offer rate of 4.49%, you’d be making monthly payments of approximately $436 (including levies, freight and pre-delivery Inspection, and fees).
By the end of your lease, you will have paid the dealership approximately $15,700, and the vehicle would have a lease end value of $12,682.
Keep in mind that this lease end value is estimated when you begin your lease, but because of depreciation it might be higher than what the car is worth at that point in time.
If you wanted a different car at this point, you would be free from your commitment and you could enter a new lease – but that $15,700 would be gone forever. Again, this is similar to when your home’s rental agreement is up and you need to move out. All that rent and lease money builds equity for somebody else.
If you wanted to buy the car at the end of your term, you could pay the remaining lease end value plus taxes and fees. With this option (taking into account what you’ve already paid plus the remaining value, taxes, and fees) you’d pay more than $30K for the car.
In contrast, if you opted to finance the purchase of this same vehicle over the same three-year period, with no down payment, the dealership would offer you a rate of 4.09%, and you’d need to pay $805 per month.
That’s nearly double the amount of the lease, but by the end of its term, you would have paid approximately $28,980 for the car and it would be yours to keep.
With leasing you also have to worry about the terms of your contract. For example, dealerships usually impose a maximum yearly mileage cap that you need to stick to, to avoid extra fees. And you have to do regular maintenance and upkeep of the car throughout your lease if you want to close it without buying the vehicle.
You also need to consider early termination stipulations and charges for regular wear and tear while thinking about your leasing options.
So deciding what’s best between leasing or buying really depends on what you want, what you can afford, and what best suits your needs.