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Leasing vs. financing a car (and how it affects your insurance)

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Choosing your new car is a big decision, but that’s not the only decision you’ll have to make. Will you lease, finance, or buy the car? And how will it affect your auto insurance

What is the difference between leasing and financing a car?

If you don’t have the cash to buy a new car outright, your best options are to either lease or finance a car. But what’s the difference between the two?

Leasing a car is essentially renting a vehicle for a long time. By making payments each month, you can use the car until the end of the lease. Leases typically last for a few years, and after that, you can return the car and shop for other options as you don’t actually have ownership tied to the vehicle. In some cases, you can also buy or finance the car after the lease ends. 

Financing a car is similar to a mortgage. You make monthly payments like leasing, but once the loan is paid off, the car belongs to you. 

Pros and cons of leasing a car

If you’re considering leasing a car, there are a few pros and cons you should consider to ensure it’s your best option. 

Benefits of leasing a car

  • Lower upfront costs
  • Lower monthly payments
  • Car is always under warranty
  • Can easily switch to a new car every few years 

Because you're only paying to use the vehicle and the cost of depreciation, the upfront costs are generally cheaper. The manufacturer’s warranty should also cover you for the entire lease period, so you don’t need to pay for repairs. Lastly, if you want to switch up your car every few years, leasing is the way to go. 

Drawbacks of leasing a car 

  • Kilometer restrictions
  • Additional charges for damage
  • No ownership of the car

Aside from not owning the car, a big drawback of leases is that they often have specific kilometer restrictions, and going over it may result in a penalty. For instance, you could be charged $0.10 for every km you go over which would add up if you’re planning on taking road trips every weekend. If the car is returned with more wear-and-tear damage than average, you might also need to pay additional fees. So do your homework and research to make sure you understand the terms of your lease. 

Pros and cons of financing a car

Financing a car is a better investment than a lease. You’ll eventually own your car and drive it for a long time, and your car payments eventually go away. However, it might not be the best option for everyone as there are still benefits and drawbacks to consider. 

Benefits of financing a car

  • Ownership of the car 
  • No more monthly payments after the loan is paid off
  • Can sell or trade-in the car for equity
  • No kilometer restrictions 
  • Can drive the car long term

The biggest benefit to financing a car is that you’ll actually own the vehicle after the loan is paid off, and you won’t need to worry about setting aside this money for month-to-month payments anymore. This also allows you to customize your ride freely, and sell or trade-in your vehicle for cash when needed. You can also drive as much as you’d like and keep the car until it dies. 

Drawbacks of financing a car

  • Higher payments each month
  • Out of pocket repair costs after the warranty expires

The main drawback to financing a car is having a higher monthly payment because your payment is calculated based on the entire price of the vehicle and the loan interest. Lease payments are based only on the period you’re renting the car for. Additionally, after the new-car warranty expires, you’ll also have to pay for any repairs out of pocket if it isn’t covered by your auto insurance. Remember, car insurance is for the sudden and unexpected. If you want to protect your physical car, you’ll also need comprehensive and collision coverage. 

Is it cheaper to lease or finance a car?

Whether leasing or financing a car is cheaper depends on your perspective and timeline. 

In the short term, leasing will be cheaper than financing. Generally, lease payments will be 30-60% lower than a loan payment, assuming all factors are the same in both cases, including the vehicle model, the price, the term length, and the downpayment. 

In the long term, financing a car will be less expensive than leasing a car if you decide to keep the vehicle after it is completely paid off. This way, you can drive the car for many years, and the cost you paid during the loan period can be spread out. For instance, let’s say you finished financing a vehicle for $30,000 and plan to drive it for as long as possible. The one price of $30,000 could potentially be spread over 10 years while leasing means you would still be making month-to-month payments all this time. 

The effect of leasing vs. financing on your car insurance 

When it comes to auto insurance, providers don’t technically look at whether you are leasing or financing to calculate your rate. Instead, companies look at vehicle-specific factors, such as the make and model of your car, and personal factors, such as your driving history and age. 

However, you still need to let your insurer know about your lease or loan. The leasing company or financier will want protection for the shared asset. If your car is a write-off, your insurance company will determine the value of the car in its pre-accident state. Then, they give your leasing company or financier this money to cover any remaining payments you owe. 

When the value of your car exceeds the amount owed, you can keep what’s left. Typically though, most cars are worth less than the amount remaining on the loan. Enter gap insurance ー you can buy this from your insurer or dealership and cover the space in between. 

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What is gap insurance?

Gap insurance covers the difference between what you owe to your leasing company or financier and the amount your insurance company will pay if it gets totaled. It is usually a one-time fee costing anywhere between $350 and $800. 

Let’s say you just leased a car for a total of $30,000, but with taxes and registration fees included, the total cost becomes $32,000. With a 10% down payment (or $3,200), you would still owe $28,800 in monthly payments. However, your car could depreciate at 20% in its first year, and in an accident where your car is a write-off, your insurance company would value it at $24,000. That leaves you with $4,800 of unaccounted debt to pay. Gap insurance, if you have it, will cover this amount. 

leasing-vs-financing-car-gap-insurance-graphic

Do I need gap insurance?

Gap insurance can be a worthwhile investment as it protects you from overpaying on a vehicle that might not be valued as much as you owe. You should consider making the purchase, especially if your car has a high price value and is known to depreciate quickly (eg. sports cars and luxury vehicles) or your down payment is low. Some leasing companies and financiers might also require you to purchase it for newer models. Vehicles that are under 3 years of age benefit from gap insurance most because cars lose their value quicker at the beginning. However, it might not be for everyone as the probability of your car being in a total loss accident during the gap period is a risk many are willing to take. 

The bottom line 

The decision is up to you. Whether you choose to lease or finance a car, there are a few advantages and disadvantages to both, and one will probably meet your needs more than the other. For more details on leasing and financing and its impact on auto insurance, you can always speak to your car dealer or your auto insurance broker.

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