When shopping for a car, you have a few buying options: paying cash, financing, or leasing. Unless you've saved for years, paying cash generally means buying an inexpensive car just to get by, so most buyers looking for a newer car often finance or lease their vehicle.
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It's easy to get leasing and financing mixed up, as each involves making a monthly payment, but there are some significant differences. In this guide, we explore lease vs. finance to help you decide which option will work best for you.
Lease vs. Finance
While you can put a new car in your driveway through leasing or financing, they are very different processes. Here’s what you need to know when it comes to lease vs. finance options.
What Is Auto Financing?
Another term for auto loan, auto financing is when you accept money from a lender to pay for a vehicle. The lender will give you the money or fund the dealership directly, and you make monthly payments to the lender.
An auto loan generally includes an interest rate — expressed as an annual percentage rate (APR) — which is how the lender profits from lending you the money. Your interest rate depends on several variables, including whether the vehicle is new or used, your credit score and profile, your down payment, the amount you're financing, the loan length, and more.
In some cases, lenders will offer special 0% financing on new vehicles, but these are generally from captive lenders, meaning they are associated with or owned by the automaker. The automaker uses these 0% APR offers to sell more cars.
While making the monthly loan payments, the lender places a lien on the vehicle's title. After you pay off the vehicle, the lender will release its lien from the title and send the title to you. At this point, the car is 100% yours, making it an attractive option for car shoppers who plan to keep their vehicle for four years or longer.
What Is Auto Leasing?
Leasing a car is a lot more complex than financing one. Essentially, a lease is a long-term rental contract. For the most part, leases are only available on new cars, but you can sometimes find newer used cars available for lease through third-party dealers.
When leasing a car, you can still have monthly payments, just as you would with an auto loan. However, the monthly payment is based on the vehicle's depreciation — the car's MSRP relative to its value at the end of the lease term — instead of just its price. As such, lease payments are normally lower than monthly financing payments.
You can pay money down at the start of the lease to reduce your monthly payments, but this generally isn’t required unless the manufacturer asks you to also pay freight and other preparation fees upfront.
Speaking of the lease term, it’s generally shorter than an auto loan. While leases often last 2-4 years, a car loan can be 1-8 years. The longer financing terms can sometimes make the monthly loan payment lower than a lease payment.
The most significant difference between lease vs. finance is what happens at the end of a lease term. Once the lease runs out, you can return the car to the dealership (provided you meet the strict agreed-upon terms — more on that in a moment) or buy out the lease with cash or an auto loan.
What You Need To Know About Leasing
Leasing seems like an attractive option at times. Not only do you get a brand-new vehicle for less per month than financing it, but you get to swap it for a new car every 2-4 years. But before diving into that car lease, there are a few things to keep in mind about a lease agreement.
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The Automaker Is Usually the Leasing Company
In most cases, when you lease a vehicle, you do it through the automaker's captive financing arm, like Toyota Financial Services or Honda Financial Service. This means the leasing company is the automaker.
Driving Limitations
Since a lease means you're essentially renting the car from the manufacturer, it intends to resell the vehicle after you return it to the dealership. The last thing it wants is a vehicle with a pile of kilometres (km) on it, so they impose strict limits on the yearly km you can put on the vehicle. If you exceed these limitations, you will pay a fee at the lease’s end.
The common limitation is 20,000 km per year, but some offer ultra-low 16,000-km limits. While these are greater than the average 15,200 km the average Canadian drives per year, you could be in for a pricey surprise if you drive more than that. If you believe you’re going to exceed your mileage allowance, you can purchase additional miles from the manufacturer.
On average, manufacturers charge 8-20 cents per km over the limit at the end of a lease. So, if you had a 16,000-km-per-year limit on a three-year lease and ended up with 80,000 km when you turned the vehicle in, you'd pay $2,560-$6,400 in fees when you turned in the vehicle.
Keep in mind, you’re not charged on kilometres each year. Instead, it’s the cumulative kilometres over the course of the lease. For example, on the 16,000-km lease above, you can drive a total of 48,000 km during the three-year lease.
Buyer beware that manufacturers will sometimes exaggerate the mileage penalties to make the fees seem higher at lease end. Then they will offer to waive the fees if you agree to sign a new lease.
Modifications Prohibited
Again, a lease is little more than a long-term rental, so the lender doesn't want you modifying the vehicle. No paint. No special wheels. No performance upgrades. No upgraded speakers. Nothing. No tinted windows. Why not? That hot-pink paint job and 22-inch chrome wheels may be something you love, but another buyer may not. If you attempt to turn in a vehicle with these modifications, you'll likely incur a significant fee to return the vehicle to its original condition.
Tax Benefits
When you lease a vehicle, you can deduct the business-use portion of the monthly payment from your taxable income, but the limit is $800 per month plus harmonized sales tax. If your monthly lease payment is $500, and you use the vehicle 80% of the time for business, you can deduct up to $4,800 per year.
Eligible for Trade-In or Sale
If you want to get out of a lease early, you can trade it in or sell it at any time during the lease, just like any other car. The difference is you must first determine the vehicle's residual value when you plan to sell or trade it in.
Your leasing company should offer a way to view the current and future residual value online. If this isn't available online, you can call the leasing company to get it.
You then determine the vehicle's value as a private sale or trade-in. If that value is equal to or higher than the residual value, you may be able to sell the vehicle with no money out of pocket. If it's lower than the residual value, you can still sell or trade the vehicle during the lease or at the end of your lease, but you'll have to pay the difference to release the title.
Want to take the hassle out of selling or trading your leased vehicle? Head over to Clutch's online vehicle estimator to get a valuation. If the valuation is suitable, you can trade your leased vehicle on a quality used Clutch vehicle or sell it to us. We'll pick the vehicle up and handle all the paperwork.
What You Need To Know About Auto Financing
If financing is the best route for you, there are still a few things you need to know before signing an auto loan agreement.
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You Own the Vehicle
Unlike a lease, where you have to either finance the remaining value of the vehicle or simply turn it in, you own the vehicle after completing the finance terms. This makes auto financing a great option for people who like to keep their vehicles for the long haul.
Modify To Your Heart’s Content
If you enjoy modifying your vehicle with wheels, audio upgrades, and other customizations, financing allows you to do so without worrying about voiding the terms of your lease contract. Keep in mind, if you buy a new car, these modifications may void your manufacturer warranty.
Upside Down Loans
Because cars depreciate — especially in their first two years — you may owe significantly more on your loan than the vehicle is worth. So, if you plan to trade in your vehicle within the first few years of financing it, you may have to pay cash on top of its trade-in value.
Used cars, especially those two years old or older, depreciate more slowly, so buying a used car could benefit chronic car swappers.
Interest Rates Vary
Dealerships will often advertise the lowest possible interest rates to attract shoppers. Keep in mind that these super-low rates are only for shoppers with the best credit scores. Most shoppers will fall into second-tier financing and pay somewhere in the 4-5% range.
Other factors can impact your interest rate. First, new cars generally have the lowest interest rates because their future resale value is more predictable and manufacturers that finance through a captive financing company can make up that lost profit elsewhere. Also, if the loan amount is high or you choose a longer loan term, the interest rate can be higher.
Remember to also include all your fees when considering financing, including freight, pre-delivery inspection, and air tax. This can add $2,000-$3,000 to the amount you must finance, which can impact your interest rate.
Benefits of Financing Through a Dealership
If a dealership marks up your interest rate and resells it to you, why should you even bother financing through a dealership? Here a few reasons financing through a dealership is a good idea.
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Promotional Interest Rates
We've already discussed the potential for super-low interest rates, even 0% interest in some cases. These offers are generally only available through a dealership and on new vehicles. These low interest rates not only result in lower monthly payments, but they can also dramatically decrease the loan’s total cost.
Complete Your Cars Shopping in One Stop
When you handle financing your car at the dealership, you can get everything done at once. When you secure financing elsewhere, you must find the car you like, apply for the financing, and then return to the dealership to buy the vehicle. This extra time isn’t just inconvenient, but it could also result in the car getting sold before you can secure financing.
You May Be Able To Negotiate the Financing
Traditional dealerships tend to mark up their interest rates, so it may be high initially. You can go through the headache of negotiating the rate in hopes of getting it closer to the rate you can get on your own.
We do things differently at Clutch. There’s no need to put on your negotiating hat when financing at Clutch. We submit your credit profile to multiple lenders and find you the best rate. No need to haggle.
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When you're looking to buy a quality preowned car, you can handle the entire buying process online — even the financing — with Clutch, Canada's first fully online car-buying experience.
All our vehicles go through a 210-point inspection before they go on sale, and all online purchases come with a 90-day or 6,000-km warranty. Plus, if you don't love your Clutch vehicle, you can return it for a full refund or exchange it for a different Clutch vehicle in the first 10 days or 750 km.
Are you looking to trade in your old vehicle? We can handle that too, even a leased car. Navigate to the Clutch online estimator and enter some basic details to get a trade-in estimate. You can get an official offer by entering a few more bits of information and submitting pictures of the vehicle. If our offer works for you, we'll pick the vehicle up and handle all the paperwork for you.
