Picture this: you’re at your local car dealership, and you’ve just finished carefully selecting all the features you want on your next new car. You’re giddy as the salesperson guides you into the finance manager’s office, who sits you down and asks the question: do you want to lease or finance your new vehicle?
This question can throw you for a loop, especially if you’re not sure of the differences between financing and leasing a new car. Here, we’ll walk you through everything you need to know about these options so you’ll be prepared when you next pay a finance manager a visit.
Finance vs Lease
- What is Car Finance?
- What is a Car Lease?
- A Third Option: Buying Outright
- Frequently Asked Questions
What is Car Finance?
Financing is the tool you use when you want to eventually own the car you’re buying but you don’t have the money to pay for it up front. Put more simply, you’re taking out a loan for the value of the vehicle, and once you pay that car loan back, you own it. A car doesn’t have to be new to be financed: a used car can be financed, too. In both cases, roughly 50 percent of vehicle purchases in Canada use some form of financing.
When you set up financing for your vehicle purchase, you have two options: you can take the financing offered by your car dealer, or you can get financing through a third-party lender such as your bank. It’s a good idea to explore both of these options to see which can offer you the best rate.
And how do you know when you’re getting the best rate? There are a few things to consider. The easiest one to spot is the interest rate, which is represented in the annual percentage rate or APR. This is essentially the fee you pay to your lender for borrowing the money, and it can vary widely depending on the vehicle you’ve chosen, the Bank of Canada’s key rate, and other factors. As a general rule, a lower APR means you’ll pay less for the privilege of borrowing over the life of your auto loan.
Another important factor is your loan’s term, which is the length of time it will take for you to pay off your loan. This is usually set out in a number of months, with 60-month (five-year), 72-month (six-year), 84-month (seven-year), or 96-month (eight-year) terms all being common in Canada. A longer term means lower monthly payments, but it also means you’ll pay more in interest over the life of the car loan, and it will also take longer for you to pay back the amount you’ve borrowed. This can become a problem if, for example, you need to sell your car early, you’re involved in a crash your car insurance won’t cover, or your car needs work and the warranty is expired, and you still owe more on your loan than the car is worth. Higher monthly payments mean you’ll own the car faster, so it’s important to balance this possibility against choosing a loan term that makes your loan payments affordable for you.
Finally, you may be offered the chance to make a down payment, or in some cases it may be required. This is a lump-sum payment you make to secure the car loan. Making the largest down payment you can afford is a good idea as it makes the amount you need to borrow lower, which will reduce your monthly payments and lower your total interest paid over the course of the loan. In some cases, a dealership may accept your old vehicle as a trade-in instead of a down payment.
This brings us back to the original question: should you finance with your car dealership or a bank? The answer is you should finance your new car with whichever one gives you the best balance of a low interest rate over the shortest term available that gives you monthly payments you can afford. Sometimes that’s the dealer, if they have a very low or zero-percent promotional rate for the car you’re buying and you have an excellent credit score. Sometimes that’s the bank, if the car you want is in high demand and your dealership doesn’t have much incentive to offer you a great deal. By doing some research and comparing their offers, you’ll walk away with the best possible deal for you.
When the loan is paid back in full, you’ll own your car and can keep it for as long as you want, sell it to recover some of its value, use its trade-in value toward your next vehicle, give it away to a family member, or otherwise do whatever you’d like with it. Once the financing is paid off, that car is yours.
What is a Car Lease?
Another way to pay for a new car is by securing a lease. This can be a great solution if you enjoy switching into the latest and greatest new car every two to three years, or if you don’t want to be tied down into a longer-term loan.
It’s important to know the downsides, though. Leasing a car means you never own it at any stage in the process. By leasing, you’re essentially paying to borrow the leased vehicle for a short term relative to the longer periods typically seen in financing. Your car lease payments will be calculated based on the difference between the car’s price when it’s brand new and what the leasing company estimates it will be worth at the end of the lease. This means you’re paying for the change in value over that period, which is also known as the car’s depreciation. You may be required to pay a security deposit up front in order to qualify with some leasing companies.
Because you’re only paying for the cost of depreciation and administration, you can often find more affordable monthly lease payments than you would through financing. However, the leasing company will be expecting the car to be returned at the end of the car lease term in a condition that lets them recover the full amount they estimated the car would be worth. That means they’ll set limitations on you such as how many kilometres you’ll be able to drive each year and what condition the vehicle should be in when it’s returned, and you won’t be allowed to make any modifications to it. If you return the vehicle and it doesn’t meet these conditions, you’ll be expected to pay for the difference in its current or residual value versus what was estimated in the lease contract.
When the car lease term is up, you’ll typically be offered the chance to pay the car buyout amount for its resale value when it’s returned, or you can simply return it and choose another vehicle at that time. But you won’t own the vehicle or have any equity in it when the lease is done, and breaking a car lease agreement is a hassle and often an expensive process between early termination fees and finding someone to take it over until the end of the lease term. It’s important to consider these factors when deciding whether a vehicle lease is right for you.
A Third Option: Buying Outright
If you choose a vehicle you can afford and you have the money to do so, you can buy a car upfront with cash. For you as a car buying individual, this is the ideal scenario: you won’t need to make car payments or pay interest or any finance vs lease car administration payments. It’s the most direct route into car ownership as you’ll immediately own the vehicle and can do anything with it you please.
It's possible that some dealerships may try to talk you out of this option by trying to sell you a more expensive vehicle or otherwise convince you that you need to buy their financing or leasing products. This is where dealerships make a lot of their profits. Buying a vehicle with cash is not a reasonable expectation for many Canadians, but if your financial situation allows for it, it can be a smart decision.
Frequently Asked Questions (FAQs):
What is the difference between lease and finance car?
When you finance a car, you borrow the money to buy it, and you own it once that loan is paid off. When you lease a car, you make a monthly payment to borrow it from the dealership for an extended period of time, but you never own the car and you’ll need to return it when the lease period is finished.
Why do mileage limits matter?
When a dealership leases a car to you, they estimate how much it will be worth when you return it, and part of that estimate is based on how many kilometres you agree you will drive. If you return a car at the end of a lease with more kilometres than stated in your lease contract, the car will be worth less than the dealer estimated and you’ll be expected to pay the difference.
What happens at the end of a car lease?
At the end of a car’s lease term, you can either buy the vehicle for whatever it’s worth at the time of the return, or you can give it back to the dealership. If the car is worth less than the dealership estimated it would be due to damage, excessive wear and tear, or being driven too many kilometres, you’ll be expected to pay the difference in the estimated versus current value.