Buying New Car

When you purchase a car, you pay the full price of the car regardless of how much you will use it.  And since most people cannot afford to buy a new car outright, you also have to pay the interest charges for the car loan.

You also have to pay the applicable sales tax on the full value of the new car.  In essence, the total cost of ownership of a new car includes the down payment, sales tax and monthly installments for the car.  Total cost of car ownership also includes the insurance costs and gas expenses, but since these are applicable for leased cars as well, we can discount them here.

Car Lease

In a car lease, you do not pay the full price of the car, but basically only pay for what you actually use.  The value of the car that you actually use up during the lease period is called the depreciation value.  Let’s say the new car prices are $25,000 and you want to lease it for three years.  Let’s also say that at the end of three years the car will be worth $10,000 (this is called the residual value – set by the manufacturer or leasing company).  Therefore, you have effectively used up $15,000 of the value of the car in 3 years, which is what you will have to pay for.  Residual value is also affected by how many miles are included in your lease – the more miles you are allowed, the less the residual value will be at the end of the lease period (and the more the car will have depreciated), making your monthly payments higher.

At the time you enter into the car lease contract, the residual value of the car will be determined.  The difference between the new car price and the residual value is what you have to pay.  You can either make the full payment, a small down payment, or no down payment at all.  If you choose not to pay the full amount that you owe at this time, you will have to pay this amount in equal monthly payments.  You will also have to pay a finance charge which is the interest on the money that is invested in the car.  This finance charge is paid to the leasing company and is calculated on the basis of what is known as the money factor.

The "money factor" is a decimal figure that is used by leasing companies to calculate the interest that you owe them.  Money factor is typically a figure something like 0.00333. When the money factor is multiplied by the number 2400, you will get the rate of interest charged.  For instance, a money factor of 0.00333 will translate into an interest rate of about 8%.  Ask the car dealers about the money factor being used, so you know if you are getting a fair rate!

Therefore, your monthly lease payment will include the monthly depreciation charges, finance charges, and the sales tax on the monthly figure.

Mileage Allowances in Car Lease

At the time of the car lease, the number of miles that you are allowed to drive the car each year will be specified. This figure typically ranges between 10,000 miles to 15,000 miles per year.  If you exceed this quota, you will have to pay about 15 to 25 cents for each extra mile driven.

If you know for sure that you will need extra miles, it is best to purchase them upfront, as they are usually sold cheaper at that time.  However, if you’re not sure about your usage and there is a possibility that you may want to terminate the lease before the time is up (account for any early termination penalties), you should never purchase the miles upfront.  The money will not be refunded to you if you don’t use the extra miles.

Buying A Car Makes More Sense If:

• You will be using the same car for more than 3 years.
• You derive more personal satisfaction from being a car owner.
• You are more concerned with long term savings than having a new car every few years.
• You do not mind the work and expense required to sell the car when you wish to replace it.

Leasing A Car Makes More Sense If:

• You like to drive the latest cars every 2 to 3 years.
• If you will be using the same car for under 3 years.
• If it does not matter to you whether you own or lease the car as far as your friends, family and colleagues are concerned.
• If lower monthly payments and short term gains are more important to you than long term savings.
• You are leasing a car with a high residual value, so you are paying less for what you use.

To help you make the right choice, you can use a car buying vs. car lease calculator (usually available for free online) that will show you the financial implications of your choice.