When you’re in the market for a vehicle, one big decision you need to make is whether to lease vs. finance a car. A car lease usually comes with lower monthly payments than an auto loan. But at the end of the lease term, you’ll either need to buy the vehicle or lease another car. When you finance a car, you might make higher monthly payments, but they all go toward building equity. You’ll own the vehicle outright once you pay off your loan.

Leasing and financing can each make sense, depending on your preferences and financial goals. We’ll give you a road map of how leasing and financing compare, as well as the insurance considerations for each.

Car buying options: Leasing vs. financing

The average new car purchase price was $47,401 in early 2024, according to Kelley Blue Book. Meanwhile, the average used car list price was $25,540. If you need a vehicle and you don’t have that kind of cash saved, your options are to lease or finance a car.

Leasing a car

When you lease a car, you’re essentially renting it for the long term. You’ll sign a lease agreement that specifies how many months the contract will last, the monthly payment, and a mileage limit. If you go over the mileage cap, you’ll be charged a per-mile fee.

There are a few key details you need to know as the lessee, i.e., the person leasing the car, before you sign an agreement:

• Capitalized cost: Sometimes referred to as the cap cost, this is basically the agreed-upon value of the car, plus the taxes, title, and registration fees, and any add-on protections you purchase.

• Lease term: The amount of time your lease will last. The average car lease term is three to four years, though shorter-term and longer-term leases are available.

• Residual value: This is the amount the dealership estimates your vehicle will be worth at the end of the lease, accounting for typical car depreciation. It’s expressed as a percentage of the car’s MSRP. For example, if you sign a three-year lease on a $40,000 car and the residual value is 60%, the dealer estimates that your vehicle will be worth $24,000 at the end of the lease. Usually, this number isn’t negotiable.

• Money factor: This is essentially the car leasing term for the interest rate you’ll pay. Usually, this number is a decimal. To get the annual interest rate equivalent, multiply the number by 2,400. For example, if the money factor is 0.0020, you’d multiply 2,400 x 0.0020 to get an interest rate of 4.8%.

Once your lease period ends, you’ll typically have the option to return your car, buy it, or extend the lease terms.

Financing a car

When you finance a car, you take out a loan and make monthly payments until the loan is paid off. The car itself serves as collateral for the loan; if you don’t make your payments as agreed, your lender can repossess the vehicle. You’ll own your car outright once you pay off the car loan.

If you’re financing a car, make sure you know these things before signing a loan contract:

• Principal: The total amount you’re borrowing for your vehicle loan. This amount will often be lower than the car price if you have a down payment or trade-in.

• Interest rate: The annual cost you’ll pay to borrow money. The average interest rate on a 60-month new vehicle loan was 8.20% in the second quarter of 2024, according to the Federal Reserve board. Your credit score is an important factor in how much interest you pay.

• Total cost: The total amount you’ll pay for the vehicle, including the principal loan amount, taxes, fees, and interest.

• Loan term: This is the length of time in which you’ll pay off the loan. Average new car loan terms range from 62 months to 74 months, according to Experian’s State of the Automotive Finance Market Q4 2023 report.

You can typically get a car loan from banks, credit unions, online lenders, or the dealership where you’re buying your vehicle.

Pro tip: The shorter the term, the higher your monthly payment will be, but you’ll usually pay less in interest over the life of the loan.

When it makes sense to lease

Leasing a car often makes sense if:

• You want lower monthly payments: Average car payments on a leased vehicle were $587 per month for borrowers with top credit scores at the end of 2023, Experian reports. New car loan payments for the most qualified buyers averaged $703 per month in the same period.

• You like driving a new car. At the end of your lease contract, you won’t have any equity in your vehicle. That’s why leasing a car works best for people who only keep their cars for a few years and are OK with always having a monthly payment.

• You don’t drive a lot. A lease agreement limits you to a certain number of miles a year. A limit of 12,000 miles is typical. Beyond that, you could pay an excess mileage fee of around $0.20 to $0.30 per extra mile. If you went 10,000 miles over this limit, you could pay as much as $3,000. That’s why it’s best to avoid leasing if you have a long commute or you take frequent road trips.

• You’re hoping to avoid maintenance issues. Though you’re typically responsible for ongoing maintenance associated with a leased car, you’re driving it during the early years before major repairs typically become necessary.

When it makes sense to get a car loan

• You plan to keep the vehicle for a long time. If you want to keep your car for more than the typical three- or four-year lease period, financing a car is usually the better move. After you pay off your loan, you may be able to get several payment-free years out of your car.

• You don’t care about having the newest car. If you don’t care about driving a new car with the latest features, financing a car and keeping it long-term usually makes sense.

• You put a lot of wear and tear on your vehicle. In addition to an excess mileage fee, you’ll get hit with extra charges if the wear and tear on a leased vehicle is above the car manufacturer’s guidelines. If you rack up high mileage or drive in rough terrain, financing your vehicle is probably wise.

Pros and cons of leasing vs. buying

There are several pros and cons associated with leasing vs. buying a car.

Insurance considerations for leasing vs. financing a car

Whether you buy or lease a car, you need an insurance policy that meets your state’s minimum coverage requirements. Most states require you to carry liability coverage for bodily injury and property damage. Some states have additional requirements, such as PIP insurance or uninsured/underinsured motorist coverage.

Most lenders and car financing companies also require you to buy comprehensive and collision coverage to protect their financial interest if you have a lease or loan on your vehicle. If you’re financing a car, you can drop these coverages from your insurance policy once you’ve paid off your car loan. However, you’ll need to keep your comprehensive and collision coverage as long as you’re leasing a car.

Some car leasing companies require lessees to carry liability coverage limits above the state minimums. If you need higher coverage limits because you’re leasing a car, you can expect to pay more for insurance premiums.

You may also need something called gap insurance if you lease or finance a car with little money down. On a leased vehicle, gap insurance covers the difference between what you still owe on the lease versus the car’s actual cash value or the amount the car is worth after factoring in depreciation. If you’ve financed a vehicle, gap insurance covers the difference between what you owe on the car and its current worth.

If you’re comparing the monthly costs of buying a vehicle with financing or leasing one, be sure to account for all expected expenses, including car insurance.

Read more: All about car insurance on a leased vehicle

FAQs

Is leasing a car better than buying?

Leasing a car may be better than buying if you only keep cars for a few years, you want a low monthly payment, and you don’t put major wear and tear on your vehicle. Buying tends to be a better deal if you keep vehicles for a long time and you want to build equity, or if you drive a lot and would go over the mileage cap on a lease.

What are five disadvantages of leasing a car?

Five disadvantages of leasing a car are that you won’t own the car, you’ll always have a car payment, you’ll have limited mileage, you’ll pay several fees, and you typically can’t customize your vehicle.

Does leasing a car affect your credit?

Yes, when you lease a car, your car payments will be reported to the credit bureaus. On-time payments will help your credit score, while late or missed payments will hurt it.