By Grace S. Yung, CFP
Throughout life, many people will strive to acquire assets such as a home, a car, and savings and investments for future needs. Since you probably aren’t able to simply write a check to pay for a home or car, you will typically need to finance at least a portion of the purchase price. Alternatively, you could lease or rent. But which is the better option? It depends.
Should You Lease or Purchase Your Vehicle?
Over the years, there have been numerous debates over whether leasing or buying a car is the better way to go. There are people who swear by both. But the reality is that it really depends on your specific situation.
While buying or leasing anything can be somewhat confusing, in the case of automobiles it can be almost overwhelming because of the price haggling and other negotiations that can go on for hours before you even reach an agreement.
It is important to have a good understanding of what each scenario entails, how much it will actually cost you, and what you will be getting for your money. There are pros and cons to either option.
Car Purchase Pros and Cons
When you finance a car with monthly payments, you will own it at the end of the loan’s term. This is definitely one of the biggest benefits, especially if you keep the car for a long period of time and no longer have any payments on it. Once your car is paid off, you could even continue making that same “payment” into a savings or investment account to build up for a future car purchase.
Owning the car also means that you have a tangible asset that you can sell or trade in when the time comes to purchase a new car. Often, the value of your trade-in can be used as your entire down payment on the new vehicle—and then some.
If you own a car, you have no restrictions on the mileage that you can put on it, so you’re not constantly watching the odometer and worrying that you’ll have to pay a penalty for going over the mileage limit like you would if you leased the vehicle.
But owning a car can also have some drawbacks. For example, the car’s original value is quickly eroded by depreciation, especially in the first few years. In fact, if you make only a small down payment on your vehicle and finance the rest, you may find that you actually owe more on it than it’s worth.
Car Leasing Pros and Cons
When you lease a car, you are basically renting something that you must return to the dealer after the term of the lease expires. While some people may not care for this option, for others it is ideal.
For example, if you are someone who ends up going out every few years and searching for the latest models to purchase, then leasing may be something for you to consider, as you won’t take the depreciation “hit” when you go to trade in a car that you own. Leasing can also offer business owners tax advantages if the vehicle is used for business purposes.
However, one of the biggest factors to keep in mind when considering the lease-versus-buy question is that when you lease, you will never end up owning the car—even though you will always have monthly payments to make.
In addition, leasing will typically come with mileage restrictions on the car. Since most leases restrict the number of miles that you can drive each year to 12,000 or 15,000, leasing may not be your best option if you are behind the wheel frequently. Excess driving could cost an additional 15 to 25 cents per additional mile you drive, depending on the type of vehicle you lease.
Since you’ll probably own or lease multiple vehicles throughout your life, you may opt to try both options, depending on your particular circumstances at the time. But what about when it comes to your home?
Buying or Renting Your Home
Buying a home has always been considered “the American dream.” One reason for this is that you can build equity over time as you pay down the mortgage and (hopefully) the value of the home increases. Many people will actually start out renting as they continue to save for a down payment on their first home. Indeed, renting can be less expensive than buying—starting with the fact that you don’t need a big down payment in order to move in.
So, what are some of the pros and cons when deciding whether to buy or rent a place to live?
Advantages of Buying
Even though most people will have a monthly mortgage payment, knowing that each time you write out that check you are inching closer to owning your home outright can be a huge plus on the buying side. This is especially true if you plan to stay in the property for at least five to seven years. Also, you have the potential of your property appreciating in value over time. (A renter’s monthly payment essentially goes toward helping to pay the landlord’s mortgage and property taxes, so renters don’t build up any type of equity in the property.)
In addition, you can take a nice tax deduction each year for both your property taxes and the interest that you pay on your mortgage—which, in the first several years, will be the majority of your payment. Renters don’t get this advantage. Although some people say that the tax-deductions benefit doesn’t outweigh the cost, it really depends on your income and whether or not your itemized deductions will exceed the standard deduction on your tax return.
But if your mortgage interest and other itemized deductions are more than your standard tax deduction listed above, home ownership can offer you a big potential benefit. While this is another area where being married may be beneficial, it’s important to do the math in order to determine what is best for you.
Some additional plusses of owning include the fact that you can redecorate and even renovate in any way you choose, provided that it passes building-code regulations. The extra space you might have in a home could even help you pay a portion of the mortgage by renting it out to a friend. (Renters don’t have nearly as much control over how they can redecorate—and they might not even be able to have a pet.)
While it is best to make a 20-percent down payment when you purchase a home, there are some mortgage programs that allow you to purchase with no money down. Unfortunately, a small down payment will mean having to pay private mortgage insurance, which increases the amount of your monthly mortgage payment.
Advantages of Renting
Even with all of the nice advantages to owning a home, there are some drawbacks that may convince you to rent rather than buy. While owning a home has traditionally been a goal for many people, a growing number of today’s Millennials are actually renting for many years before they even consider making a home
One reason for this is the great deal of flexibility that renting can offer. In an era of career uncertainties, renting provides the ability to move from one area to another without the need to sell a home. Moreover, anyone who is unsure about their income will want to wait on making any big purchase such as a home.
Waiting it out can also help keep your budget in check, as many potentially costly emergencies such as broken appliances and leaking roofs are up to the landlord to repair, not you. And in some cases, the landlord may even pay for utility costs such as water and gas. (Homeowners are solely responsible for all of those expenses, since there’s no landlord to call.)
How to Determine Your Best Next Step
Whether to rent or buy your home or your vehicle will depend solely on your specific circumstances. Often, the best way to determine the best answer for you is to discuss all of the options with a financial professional, and then develop a game plan for going forward. This can help to keep you on track with both your short- and long-term goals.
Personal finance-related questions may be emailed to [email protected].
Grace S. Yung, CFP, is a certified financial planner practitioner with experience in helping domestic partners plan their finances since 1994. She is a principal at Midtown Financial LLC in Houston and was recognized as a “Five-Star Wealth Manager” in the 2014 September issue of Texas Monthly.