When getting a new car, the two main options Canadians get are leasing and financing. The third option is buying outright; however, only some people can afford that alternative. While both leasing and financing require you to make monthly payments, the ownership makes the two different.
While you own a financed vehicle, leasing is like renting a car for an extended time period. Monthly lease payments are usually much lower than monthly finance payments, as you only pay for the vehicle's depreciation during the lease term. Finance works similarly to mortgages, and you may find different car loan rates offered by different car dealerships and lenders, just like in the case of mortgage rates. Both have pros and cons, and understanding both options can help you decide your better choice. Read below to learn more about lease vs. finance car options.
Car dealerships in Canada offer the option of leasing a vehicle of your choice. When you lease a car, you pay to use the car for a predetermined length of time, called the lease term. The common lease terms in Canada are 24 and 36 months. You must return the car to the dealership at the end of this term. Car dealerships offer the option to buy out the vehicle at the end of the lease term if you don’t want to return it.
Monthly lease payments are much lower than monthly car loan payments, as you pay only for the car's depreciation during the lease. The car's value at the end of the lease term is called residual value, which is the basis of the monthly payment calculation. The most significant drawback of leasing is that you don’t own the vehicle; thus, you don’t build any equity in it. Listed below are all the pros and cons of leasing a car.
|Lower monthly payments than financing for the same term length.||You do not own the car and do not build any equity in it.|
|Due to lower monthly payments than financing, you can afford to lease a more luxurious car for the same monthly budget.||Lease contracts come with kilometer restrictions, and the penalty for exceeding the same can be significant.|
|Leased cars usually have a warranty covering maintenance and repairs, often for the entire lease term.||You must pay an early termination fee if you terminate the contract early.|
|You can drive a new car every few years.||You cannot sell or trade in the car to offset some of the cost of the next vehicle you buy.|
|You don’t need to go through the hassle of selling the car.||If the car does not have gap insurance, you may have to bear some of the cost of the car in case of accidents or theft.|
While car leasing may seem attractive due to lower monthly costs, it is more expensive in the long run. When you finance a vehicle, the monthly payments may be higher, but you end up owning the car at the end of the finance term, and you can continue to use the vehicle for years to come. On the other hand, as long as you are leasing cars, the monthly lease payments continue. However, it may be a favorable choice for those who like to change cars every few years and do not wish to own them.
You should also remember that you may have to pay for the cleaning and sale of the car when you return it. If there is significant wear and tear to the car, you may also have to cover the repair cost out of your pocket.
Gap insurance is often included in car leases to protect you in case your vehicle is stolen or totaled. The insurance covers the difference between what you owe on the lease/loan and the vehicle's actual value. This comes in handy in a situation where car insurance does not cover the entire amount you owe on the car.
Most new cars depreciate up to 20% in value as soon as they drive out of the dealership, and car insurances cover only the depreciated value of the cars. For example, if your car’s original cost is $30,000, its depreciated value after leaving the lot may only be $24,000. This means if your car gets stolen in the first month of getting it, your insurance may only cover $24,000, and you may be left with $6,000 to pay out of pocket.
To avoid such a situation, dealerships and insurance companies offer gap insurance, which is also known as guaranteed auto protection. Gap insurance is often mandatory with leases, but you can also get one for a financed vehicle. On average, the cost of gap insurance varies between $350 to $800, depending on the vehicle you’re driving.
The popular alternative to leasing a car is financing it. Financing a car simply means getting a loan for the car, which works similarly to home mortgages. You enter into a contract with the car dealership (most car dealerships offer in-house financing) or the financing institution and make monthly payments to pay the principal and the interest. The vehicle is used as collateral for the contract.
Financing may be ideal for those who wish to own a car and intend to drive it for a long time. When you finance a vehicle, you can drive the car indefinitely, even after the loan term ends. You can also choose to sell or trade in the car anytime. Listed below are the pros and cons of financing a car.
|You will own the car once the loan is paid off, with 100% of the equity.||Higher monthly payments than leasing.|
|You can choose to sell or trade in the car at any time.||The car’s value depreciates quickly in the first few years.|
|No limits on mileage, allowing you to drive as much as you want.||After the warranty expires, you have to pay for maintenance and repairs out of your pocket if your insurance doesn’t cover them.|
|Once the loan is paid off, you don’t have to make any more monthly payments.||You will have to spend on comprehensive and collision insurance every year, even after the loan has been paid off.|
|You can continue to drive the car for as long as you wish.||Late or missed payments can attract penalties and may even result in an increased interest rate.|
While it may seem more expensive to finance a car, given the higher monthly payments, the payments are for a limited time, after which you own the car without making any monthly payments. Financing a car offers greater flexibility in the long run and is often the better option for those who do not wish to change cars every few years and would rather be free from monthly payments after the loan is paid off.
If you are using a car for your business, you can deduct some of the costs of the car from your income for tax purposes. You can expense a vehicle in the case of both financing and leasing. Many business owners question whether leasing or financing is better for them from a tax perspective.
When you lease a car, you can deduct up to $900 before HST (or GST and PST), meaning if your lease costs $1,000 monthly before HST (or GST and PST), $100 of it would not be deductible. Furthermore, if you use the car for both business and personal use, you can deduct only for business purpose use. For example, if 60% of your car’s use is for business, you can deduct only 60% of $900, equaling $540 before HST (or GST and PST). The percentage is calculated based on the kilometers driven for business and the total kilometers driven. If your leasing cost is more than $900 per month, the eligible leasing cost for passenger vehicles can be calculated using the chart provided by CRA.
The tax deduction for financed vehicles works a bit differently. Business owners can claim depreciation on any asset that has been purchased for business use. The deductible capital cost allowance (CCA) is calculated based on the asset class. Most Vehicles fall under class 10 or 10.1, defined by CRA, unless they are zero-emission vehicles (ZEV), in which case they fall under class 54 or 55. Vehicles purchased after December 31, 2021, fall under class 10.1, and their maximum capital cost is capped at $34,000 excluding HST (or GST and PST). The maximum CCA rate for both categories is 30%, and CCA allowed in the year the vehicle is purchased is 50% of the amount. The deductible CCA amount decreases with every passing year and is calculated on a declining balance basis. Since you have a loan on a financed vehicle, you may also deduct interest on that loan up to a maximum of $300 every month.
Let us assume the example of a Nissan Altima 2023 model, financed or leased in Ontario in January 2022, with a loan/lease term of 4 years, with 80% business use. It is assumed that the business owner is not registered for HST (Thus, HST is included in the claim).
Monthly lease cost (including taxes) = $617 (from Nissan website)
Monthly deductible lease expense (including taxes) = 80% x $617 = $493.6
Total deductible lease expense over 48 months (4 years) = $23,692.8
Initial cost of car (including taxes) = $37,578 (from Nissan website)
Year 1 CCA = ½ x $37,578 x 30% = $5,637
Year 1 undepreciated capital cost (UCC) = $37,578 - $5,637 = $31,941
Year 2 CCA = $31,941 x 30% = $9,582
Year 2 UCC = $31,941 - $9,582 = $22,359
Year 3 CCA = $22,359 x 30% = $6,708
Year 3 UCC = $22,359 - $6,708 = $15,651
Year 4 CCA = $15,651 x 30% = $4,695
Total CCA over 4 years = $26,622
Total deductible expense over 4 years = 80% x $26,622 = $21,297.6
Additionally, you will also be able to deduct 80% of the interest paid on the financed vehicle.
In the above example, the deductible lease expense is slightly higher than the total deductible loan expense. However, each situation is unique, and the calculations may differ based on the car’s value, interest rate, loan/lease term, and other factors. You should also consider that leasing may have slightly higher tax benefits in the shorter term, but buying may be better if you plan to keep the car for a long time.
If you have a bad credit score, your options may be limited. It may be difficult to lease a car when you have a bad credit score, as you cannot use the car as collateral in the contract. You may have to offer a higher down payment or get a cosigner to sign the lease to get a dealership to approve your lease. One option may be to take over someone else’s lease if you know someone looking to transfer their lease. Individuals with credit scores in the 600s may be able to lease a car; however, it is recommended to maintain a credit score of over 700 if you want to lease a car.
On the other hand, you may be able to get financing for a car with a bad credit score, but you may be charged a higher interest rate. It may be easier to secure financing for a car, as the car can be used as collateral for the contract. If you have a bad credit score, going through the financing route may be simpler, even if it is more expensive.
Both leasing and financing a car can help rebuild your credit score. To ensure the same, you should always make your payments on time and avoid missing payments.
While both leasing and financing require you to make monthly payments, the choice between the two largely depends on your lifestyle and financial situation. While the monthly payments on a lease may be lower, financing a car means you will be debt free at the end of the loan term while also owning the car. That said, if you are someone who likes to upgrade to a new car every few years and doesn’t mind the monthly payments, you may be better off leasing. You should evaluate both options carefully before you choose to pick one, as breaking a lease or loan contract can come with a hefty set of penalties.