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It’s estimated that around one in four vehicles is leased rather than bought in the United States. Choosing between leasing your vehicle and buying it can be a hard decision in itself. However, the decision gets even more complicated when you’re considering leasing vs. buying a car with bad credit.
Both options have pros and cons—leasing isn’t for everyone, but it depends on your situation. And your credit history and credit score can have a significant impact on your ultimate decision.
How does leasing a car work?
Leasing a car is very similar to renting an apartment. You pay a down payment and agree to a fee and a lease term. Most car leases span between two and four years. Lease terms can vary significantly from person to person, but some standard terms include:
- You’ll be charged a per-mile fee if you exceed the maximum mileage per year
- If you return your vehicle with damage beyond “normal wear and tear,” you’ll be charged a fee
- You are legally obligated to maintain insurance coverage on the vehicle
At the end of your loan term, you’ll usually have the option to buy out your car. For example, let’s say you’ve been driving a $24,000 car and have paid $15,000 over three years. You might be able to pay the outstanding $9,000 and keep the car.
Pros of leasing
There are many benefits of leasing. First, unlike with buying a vehicle, you usually don’t have to pay a sizeable down payment.
Second, your monthly payments are smaller. Since you’re just leasing the vehicle, the dealership will offer you monthly payments that are lower than if you were to buy the car outright. The smaller monthly payments also mean you could afford to lease a vehicle that would be out of your price range to purchase.
Another benefit many drivers love is that you always get to drive a new (or newer) car. As soon as your car lease is up, you can lease another new vehicle. If appearances are important to your job—such as for a salesperson or Realtor—this is a fantastic benefit.
Additionally, always driving a newer car means you have fewer repair needs, and you don’t have to deal with the trouble of selling the car when you’re done with it.
Lastly, if you aren’t sure you’re going to continue to live in your city or state for the next several years, leasing can be more convenient. You won’t have to worry about taking your car across the state or selling it when you move.
Cons of leasing
Many personal finance gurus don’t believe in leasing cars. For example, financial expert Suze Orman warns people, “I personally think you should never, ever ever ever, lease a car, do you hear me? That’s because when you lease, you’re pouring in money each month with nothing to show for it at the end of the day.”
Suze Orman is, of course, referring to equity. When you buy a car, each payment gets you closer to owning the asset. If you wanted to sell your car, you could recoup some of your investment. This isn’t an option if you’re leasing. In fact, you’ll typically be charged hefty penalties for ending a lease early.
When you rent an apartment, you’re often limited in what you can do in your own home. For example, you might not be allowed to paint the walls or install new fixtures. Well, the same is true for a car lease. Your lease will come with restrictions, such as not going over a specific mileage per year.
If you were to go on a few road trips and exceed your allowed mileage, you’d be charged a fee. Most car leases only allow the owner to drive between 10,000 and 12,000 miles per year. After this, the driver may be charged between $0.10 and $0.25 per additional mile. So if you go over by 2,000 miles at $0.25, you’ll pay an extra $500.
Ultimately, leasing is usually more expensive in the long run. This is because you don’t build equity or own an asset, and you might pay many extra fees throughout the lease term.
What credit score do you need to lease a car?
You can possibly get a lease with even a poor credit score. But your terms will probably be incredibly unfavorable. Most likely, you’ll be given a high interest rate or need to have a larger down payment with a poor score.
Ideally, when applying to lease a car, you’ll want a credit score in the Good range. For the FICO credit scoring model, a Good score starts at 670. According to Experian, the average car lease applicant in the second quarter of 2020 had a credit score of 718.
If your score is below 670, consider taking steps to improve it before applying for a car lease.
As another option, people with bad credit can opt for a lease transfer. A lease transfer is where you take over the remaining term of another person’s lease. The lender will still need to run a credit check and approve you, but the credit requirements are much more lenient for a lease transfer.
Can you lease a car with a bad credit score?
You can lease a car with a bad credit score, but it may be more challenging to find a good deal.
Many people ask about the minimum credit score to lease a car, but the truth is, there’s no hard and fast rule regarding scores. Each financing company establishes its own credit standards to determine who qualifies. As a result, requirements vary from dealership to dealership.
A credit score is usually one criterion. Financing companies use it because it provides some indication of how risky it is to lease a vehicle to you. The good news is that many dealers are willing to lend to people with a poor credit score because the credit score isn’t the only thing a financing company looks at when deciding whether to approve you for a lease. Lenders will also likely take into account:
- Income: Financing companies need to know that you make enough money to cover the cost of the monthly lease payments. As a result, they may request pay stubs or tax returns.
- Expenses: How much you owe other creditors and pay for various bills will also determine your eligibility for a lease. Financing companies want to see that you have enough room in your monthly budget to add a lease payment.
- Payment history: Finance companies may review your payment history to see if you’ve made payments on time over the last one or two years. If your credit score dropped due to previous financial problems but you’re back on track now, they may be more willing to approve your loan request.
- Recent credit activity: If your credit report shows you’ve recently taken out other new loans or opened new credit accounts, financing companies may hesitate to approve your lease. This is because you’ve yet to establish your ability to pay your lease and you’re taking on more debt.
As another option, people with bad credit can opt for a lease transfer. A lease transfer is where you take over the remaining term of another person’s lease. The lender will still need to run a credit check and approve you, but the credit requirements are much more lenient for a lease transfer.
What happens if you have a bad credit score?
If you have a bad credit score, you could potentially be turned down for a lease. However, many financing companies may approve leases even with poor credit scores. When they do, they rate the lessee as subprime and charge a higher rate of interest. This means you end up paying more per month. You may also need to make a larger down payment.
What happens if you have no credit score?
If you haven’t established a credit history, finance companies can’t accurately predict how likely you are to pay your lease. This could cause them to turn down your lease request. As with a bad credit score, having no credit history will usually result in a higher interest rate and a larger down payment if you’re ultimately approved.
How does buying a car work?
Buying a car is a more well-known process. You can purchase a new or used car and it’ll be your property. If you buy from a private seller, you’ll probably have to buy your car in cash, all up front. Alternatively, if you purchase from a dealership, you can pay in cash or finance your purchase. Plus, if you buy a car from a dealership, you can sometimes trade in your current vehicle to reduce the price.
When you lease a car, there’s typically little room for negotiations. Luckily, you have a lot more leverage when you buy a car. You can negotiate a better price or loan terms based on your down payment, car trade-in and other factors.
When you finance your car purchase, your interest rate will depend significantly on your credit score, income, credit history and other factors. You’ll be approved for an interest rate and can usually choose how long you want your loan term to be.
You can choose to finance your purchase with the dealership or through a financial institution. It’s best to compare a few options so you can secure the best rate.
Pros of buying
The main benefit of buying your vehicle is that you own it. This means you can do whatever you want with the car, including driving as much mileage per year as you wish. And, if you’re going to sell your car, you can do so and potentially make money on your vehicle.
Lastly, buying a car is usually the cheaper option in the long run, so it’s the more financially sound choice for most people.
Cons of buying
Unfortunately, buying isn’t an option for everyone because it can be more expensive initially. You may need to have a larger down payment, afford higher monthly payments and potentially pay for more repairs over the years.
Additionally, most people know that a vehicle depreciates quickly. As soon as your new car drives off the lot, it loses value. However, you can offset the cost of depreciation by purchasing a used car instead.
What credit score do you need to buy a car?
The good news is that, even with bad credit, you should be able to buy a car. Like leasing a car, your credit score matters less for approval but more for your interest rate and loan terms. While someone with a deep subprime score (300 – 500) will get an average interest rate of 14.39 percent, those with a super prime score (781+) will get a rate of 3.65 percent for a new car.
That means having a poor credit score can result in an interest rate that’s up to four times higher than those of people with fantastic scores—ouch.
If you can improve your credit score before financing a vehicle purchase, you can save yourself thousands in interest.
Can you build your credit with a car lease?
A car lease can be an effective way to build your credit. Like car loans, leases show up on your credit report. Every month, the financing company reports new information to the credit reporting agencies.
What effect a car lease has on your credit report depends on your actions. If you consistently make payments on time, your credit score is likely to improve over the course of the lease. On the other hand, late and missed payments could cause your score to go down.
Good habits can help you make the most of the opportunity a lease provides. Consider setting your payments up for automatic debit so you don’t need to worry about remembering to pay. If you prefer to pay at a different time every month, check the lease agreement to determine the due date.
Most auto leases will have a grace period of one week to 10 days. As long as the financing company receives the payment during the grace period, they won’t consider it late. After that, they could report the overdue payment to the credit bureaus. Read your lease agreement carefully to determine the grace period and when the financing company notifies the credit bureaus of late payments.
Things to consider before leasing a car
Leasing a car is a major decision. To make sure you choose the right option, consider the following.
Residual value
The residual value of a vehicle tells you how much a car will likely be worth at the end of the lease. For example, a 50 percent residual value means a vehicle will be worth half as much as its current manufacturer’s suggested retail price (MSRP).
When determining lease payments, the finance company uses the residual value as a guide. It will charge you the difference between the MSRP and the residual value. So, if a car is worth $30,000 and it has a 50 percent residual value, you pay $15,000 over the life of the lease. That amount is then divided by the number of total lease payments, and the finance company adds interest to determine how much you owe every month.
Cars with higher residual values typically have lower lease payments. The make and model are the biggest determiners of residual value, so ask about lease payments for more than one car at a dealership to compare rates.
Mileage allowance
Most leases limit the number of miles you can drive each year. If you go over the mileage, you may end up having to pay a penalty per mile over the limit.
Before signing a lease, estimate how many miles you drive for your work commute and personal business each week. Then, multiply that number by 52 to get a rough idea of how many miles you drive annually. If that number is well above the mileage allowance, look elsewhere.
What you need to pay out of pocket
You’ll likely need to make a down payment to get a lease with bad credit. How much you’ll need to pay is set by the finance company. Also, the dealership may charge you to process paperwork and prepare the vehicle. Ask exactly what you’ll be expected to pay to get your leased vehicle.
Termination fees
Even if you feel confident that a vehicle will meet your needs for the foreseeable future, ask about termination fees. Life can change unexpectedly, and you don’t want to be shocked by a large sum owed upon the early return of the vehicle.
Overall cost
To put things in perspective, add up the total cost of all your lease payments with interest included. Remember that at the end of the lease, you won’t own the vehicle. Weigh the cost versus the benefits of leasing, including not having to worry about reselling and being able to get a new car in a few years.
Other options for leasing a car
Leasing a vehicle is just one alternative to buying. One of the following options may be a better fit for your needs.
Working with the financing department
Some dealerships specialize in providing financing for people with bad credit or no credit history. Their special financing units may be able to provide you with alternatives to leasing. For example, they may have special loan programs that allow you to purchase a particular used vehicle.
Leasing transfers
Sometimes called a lease swap, a leasing transfer is when you take over another person’s lease. You become responsible for the monthly payments. Ask friends and family if they have a lease they want to get out of and check websites and apps that help you find people looking to exit their leases.
Car sharing
Many large cities are home to car-sharing services. They usually allow you to rent a car for a short period, like a week, a day or even a few hours. After the rental period, you return the vehicle. Generally, the costs of car sharing are lower than those associated with car rental services.
Choose the option that’s best for you
When deciding between leasing and buying, consider things like how much you want to spend in the long run, how tied down you want to be and how comfortable you are with paying for repairs.
Consider what’s best for you, whether that’s leasing or buying. Whichever route you take, improving your credit before you look for a car can undoubtedly save you money. You can improve your credit by paying down debt, making payments on time and filing disputes for incorrect information on your credit reports.
CreditRepair.com offers professional credit repair services. Together, we will review your credit, identify any mistakes and dispute them and even provide credit education. Contact us today to get started before leasing or buying a new car.
Note: The information provided on CreditRepair.com does not, and is not intended to, act as legal, financial or credit advice; instead, it is for general informational purposes only.
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