Leasing as a Financing Option for a New Car

Leasing is becoming more popular as a financing option for new cars. The decision whether to lease or buy is a personal one that depends on several financial and non-financial factors. These include:

  • the length of time you plan to keep the car
  • how much you intend to drive it
  • how important it is to you to have a new vehicle

The following are some of the pros and cons of leasing:

Leasing pros

Lower monthly payments. Generally, lease payments are lower than loan payments because a lease payment usually covers only the depreciation of the car from the purchase price to the residual value (the expected value of the car at the end of the lease), along with a finance charge. Rather than paying sales tax up front on the full value of the car, as one does with a loan, leasing costs reflect taxes on the monthly payment only.

Warranty coverage. Most leased cars are covered by warranties for the term of the lease for major defects and repair expenses.

Flexibility at the end of the contract. You have three options at the end of most leases: You can return the car, buy it at the residual value or lease a new car.

No resale risk. The residual value is normally agreed upon at the outset, so you know exactly how much the car will cost to buy at the end of the contract. If you don't want to buy the car, you can simply return it to the dealer.

Businesses can deduct lease payments. If an employee or company leases a car, the lease payment is deductible up to limits set by the Canada Revenue Agency.

Leasing cons

No equity. A leased car doesn't build up equity. At lease-end, you own nothing, unless you buy the car at its residual value. And while the lease cannot be used as collateral, the monthly lease payments do count against your total debt-servicing ratio.

Other costs. There may be costs upon signing the contract, in addition to any down payment, such as a security deposit, first and last month's lease payments, freight and an administration fee.

Mileage limits. The lease contract specifies the number of kilometres that you can put on the car over the duration of the lease. The leasing company will charge for any excess mileage.

Wear and tear. You must follow a specified maintenance schedule and keep good records, and keep the interior and exterior like new. If the car is returned with excessive wear and tear, costs may be deducted from the security deposit.

Strategies for leasing

  1. Focus on price and residual. Negotiate the lowest price before disclosing your intention to lease or buy. Then negotiate the highest residual value.
  2. Lease cars that retain their value. Generally, cars that retain their value will have a higher residual value and a lower payment.
  3. Choose an optimal lease term. If a car is needed for a specific period, it should not be leased beyond that term as there are penalties for cancelling early. Similarly, you should match the lease term to the warranty period, where possible, so you're covered throughout the leasing term.
  4. Avoid lease-end penalties. Not only will there be fees if you try to cancel the lease early, but there generally are limits on the number of kilometres driven. If you know you will drive more than the allotted mileage, it may be cheaper to bargain for more kilometres at the start of the lease, rather than pay higher penalties at the end of the lease.
  5. Consider buying at the end of the lease. The leasing company sets a residual value that is relatively low to ensure it can sell the car for at least that price at the end of the contract. You may want to compare the value shown in car evaluation books with the residual value to see if it might be worth buying. If you don't want to keep the car, you could sell it and pocket any difference.

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