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Shopping for a car is overwhelming. Not only must we choose between new or used, decide on a make and model, and sort through safety features and trim packages, but then we need to decide how to pay for it. If you’ve got the cash to pay for your car in full up front, it can be a smart financial move to do so, thereby avoiding interest expenses and higher insurance prices (we’ll get to that). But, most of us end up choosing between financing and leasing a new car. So, how to know what’s best? We’ll walk you through the three key steps.

1. Determine if Leasing Is for You

For some, the choice is simple: If you want to own, then you’ll choose financing. If you’re hesitant to commit to a vehicle for more than a few years, you’ll choose to lease. But if you just want make the best financial choice, you should probably consider a few different factors mentioned in The Zebra’s “Should You Buy, Finance or Lease Your New Car?” post:

Finance if you:

  • Plan to drive more than 12,000 to 15,000 miles per year (the cap for most leases, after which you’ll be subject to sometimes exorbitant fees)
  • Tend to be tough on your car or you don’t want to worry about strictly maintaining it
  • Want to make an investment and have something to trade in or resell

Lease if you:

  • Like to have a new car every three to four years
  • Like to be under a manufacturer’s warranty
  • Have traded in a vehicle previously before your loan was up
  • Want a lower down payment, lower monthly payments, and lower repair costs (because you’ll be under warranty)

David Bakke, personal finance expert at Money Crashers, offers his advice on what to ask yourself before leasing:

  • How long you’ll have to make payments: most leases are between two and four years, so you’ll be responsible for the monthly payments for between 24 and 48 months
  • How much you’ll drive: if it’s above the mileage cap, leasing might not be a smart financial decision
  • Your credit score: It not only affects your insurance rate, but also plays a role in your ability to qualify for a lease and a good interest rate. (Not sure where you stand? You can view two of your scores for free, updated very 14 days, on Credit.com.)
  • Whether you want to purchase when the lease is up: If you might, find out if whoever you’re leasing from offers the option because it isn’t necessarily standard
  • Penalties for ending the lease term early
  • Whether or not the lease is transferable
  • The warranty terms of your lease

Leasing is a commitment, and terms vary from place to place, so be sure you know what you want from the experience.

2. Lock Down Your Lease Financing Details

You can finance your lease through the dealership or through a bank or credit union, and you should compare prices for a few different options because rates will vary.

If you’ve never leased before, figuring out what constitutes a good price can seem alien, but the general formula is actually fairly straightforward. According to Edmunds, the amount you pay will involves:

  • The total price of the vehicle, which you can and should negotiate
  • The money factor (which is the interest rate on which your lease is based and is also sometimes called a lease factor or a lease fee) – you can get this number from the dealership or your credit union (depending on how you’re financing your lease)
  • The lease term
  • The residual value of the car, which is, essentially, how much of the car’s value will be left once you “use up” a percentage of it while leasing – it is usually between 40% and 65% of the total value for a 36-month lease
  • Taxes, fees, the down payment, your trade-in (not required, of course), and dealer incentives and rebates

Edmunds has an excellent lease price calculator, though they’re careful to note that you won’t be able to calculate a potential lease down to the last nickel before actually speaking with a few dealers since there are so many pricing, tax and fee variables involved (detailed in the following sections).

It’s better to pay for a down payment with your own funds, rather than borrow. “Contrary to when you buy a car, you do not want to make a significant down payment on a leased car,” Bakke explains, because if the vehicle is stolen or totaled at the beginning of your lease, you won’t recover any of that down payment. Most experts recommend a down payment of $2,000 or under.

Know What the Typical Upfront Leasing Fees Are:

The following fees are usually, though not universally, associated with leasing a car in the U.S., says Bakke. When shopping for a lease, be sure to get a list of all fees so you can accurately calculate your total expected costs:

  • Acquisition or bank fee: Charged for the work required to create the lease (usually about $500)
  • Security deposit: Usually equal to one monthly payment and returned in full at the end of lease as long as the car is in good condition
  • Disposition fee: Covers the cost of cleaning and reselling the vehicle (usually about $300)
  • Title, tag, license, and registration fees: Just like if you were buying the car (prices vary by state)
  • Documentation fee (“doc fee”): An administrative fee (usually about $500, but can vary between $50 and $700 or occasionally be negotiated down)
  • Taxes: Vary by state, but you should only responsible for taxes on the portion you lease

End-of-Lease Fees:

  • Vehicle inspection: You’ll be charged for any necessary repairs
  • Exceeding mileage: If you go over the mileage cap, you could be in for a big expense; penalty rates vary by company, but the worst-case scenario is 25 cents per mile over the cap

Can You Lease a Used Car?

Leasing a used car isn’t especially common, but it’s an option. You might find that you pay lower monthly payments since an older vehicle is likely to be worth less than a new one. However, if you lease used, the car probably won’t be under warranty (one of the major benefits of leasing), so you’d have to pay out of pocket for any repairs or servicing.

3. Know How Insurance Differs for a Lease

Whenever you buy a car, insurance should be a key consideration — after all, it’s the biggest car-related expense after financing the vehicle itself (even in front of gas).

The Zebra’s own licensed insurance agent and adviser Neil Richardson says insurance is typically more expensive on a leased vehicle than if you owned the vehicle outright. Leasing companies and dealerships want to protect their property (which will be theirs again when your lease is up), so they require high levels of insurance coverage.

According to Richardson, when leasing, you usually need to carry:

  • $100K/$300K/$50K (meaning $100,000 per person/$300,000 total bodily injury liability per accident and $50,000 in property damage liability per accident)
  • $500 comprehensive and collision deductibles
  • You might also be required to carry GAP insurance, which would cover the difference between what you owe and what the car is worth in the event of a total loss or a theft.
  • These limits are higher than most state minimums and the optional $1,000 deductibles that many insurers offer to keeps rates lower. The national average yearly premium for this type of coverage is $1,413, per The Zebra’s own State of Auto Insurance Report.

Many major U.S. insurance companies (and some independent ones) will also require you to have the same level of liability coverage for each vehicle in your household, so if you lease, rates on your other household vehicles could go up (but you wouldn’t necessarily have to add comprehensive and collision to other vehicles). In The State of Auto Insurance Report, The Zebra found that the average yearly premium for a policy carrying just the state minimum limits of liability is $529 while the average yearly premium for a policy with 100/300/100 limits of liability, with no comprehensive and collision coverage, is $692 — a $163 difference.

So, if you own a car with a policy covering only your state’s minimum limits of liability and then your household leases another car, will you have to pay an average of $163 more for the policy of the car you own? Richardson says it’s not always that cut and dry: “Drivers are usually given discounts for insuring multiple vehicles and insurance pricing on the vehicles themselves would vary based on year, make and model.”

So, should you lease? We’ve armed you with the details. Now it’s up to you!

Image: SIphotography

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