The honest answer is ‘neither’, but let’s start by understanding the two most popular alternatives.
Financing the Purchase: Lease
With a lease, your monthly payments are known, and the vehicle is typically newer and under warranty so repairs do not typically need to be worked into your budget beyond oil changes. Monthly lease payments will be lower than a purchase because you are only paying for the depreciation expense during the time you drive it, not the full cost of the car. When the lease expires, the buyout terms are known so there is no negotiation or selling process. All of the terms are decided up front, and they are all negotiable.
With a lease, you don’t actually own the asset – you are essentially renting the car. And this option works well for those who will drive below the annual cap (over which the penalties can really add up), those who don’t have the cash flow to afford to own and those who want the option of buying the vehicle at the end of the lease (remember, the buyout amount is negotiated up-front).
Financing the Purchase: Buy
For those who don’t want caps on mileage, those who look after their vehicles, and those who want to own their vehicles long enough to have their payments cease (owners typically own their cars long after payments have stopped), owning is the way to go.
Of course maintenance costs will increase as the life of the car increases, and this needs to be factored in. A tip for those who buy is to continue to save at least part of your car payments after they cease, and put it into a maintenance account so you’re ready for some of the bigger repair bills.
As usual, there is a trade-off. With a lease you will pay a premium over your lifetime in exchange for a lower monthly payment, the enjoyment of driving newer cars and fewer repairs. With an outright purchase, you’re going to come out ahead if you can commit to proper maintenance and resist the urge to upgrade every few years. If you don’t value the enjoyment of driving newer vehicles, owning will be the best choice.
Financing the Purchase: With Cash
I believe the best way to buy a car is with cash saved. The concept is a simple one: Save a set amount each month in a designated car account (preferably a Tax-Free Savings Account). When it comes time to purchase a car, look to your car account to dictate what you can afford. There is nothing like having a ‘real purchase limit’ when buying a car to stop a salesperson from getting you into a car you can’t afford. If you want a really nice car, increase your monthly savings amounts or hold out a little longer until your car fund can fund the purchase outright. Getting off the cycle of car payments for life is liberating, and buying a car with cash is just plain fun.
If all you can afford is 3 or 4-year old cars each time you purchase, you’re probably better off again, because you’ll never pay the 60% depreciation expense that those who purchase new cars are having to absorb in the first three-four years of ownership.
Cars are one of the biggest expenses we have, so it makes sense to put some time into understanding your financing options. The third alternative here takes some forethought, but if replacing your car is the most predictable and large upcoming expenses (which it is!), it’s probably worth spending a few minutes preparing for it.