For many people, nothing tends to cause more confusion over the car buying process than deciding whether to finance using a traditional loan or to enter into a lease. The answer of which one is the better choice is based on your personal situation and the key is to understand the advantages and disadvantages of both.

Both programs allow you to pay for the car over time with a fixed monthly payment. With a loan, you are financing the total cost of the vehicle (less any down payment) and, when the payments are finished, you obtain full ownership. A lease means that you are basically renting the car and at the lease's end you must return it to the dealership or buy it. The payments for a lease are based on the difference between the selling price of the car and its residual value at the end of the lease; in effect, you are paying for the deprecation in the car's value over the time that you are renting it.

While most customers are comfortable with the idea of a loan, a lease causes concern over two main areas: leasing got a bad reputation in its earlier days over hidden fees charged when the vehicles were returned, and a lease payment is more complicated to compute and therefore seems intimidating to the average person. The truth is that many states now require lease documents to clearly itemize all potential fees, as well as all of the basic numbers that are used to compute the monthly payment, and you can feel much more comfortable considering a lease for your new vehicle.

So, which one do you choose? That largely depends on your budget and your long-term plans for the vehicle.

A loan is ideal if: You prefer the idea of owning your car, rather than renting it; this gives you more flexibility both to make modifications (such as installing a new stereo) and to change vehicles whenever you'd like. You plan to keep the car longer than about three years and especially if you expect to drive it until it doesn't run anymore. The monthly payments for the car in which you are interested will be within your budget A lease is a great choice if: You tend to trade-in your car every few years, rather than keep the same one. You either want a higher-priced car for the same payment, or a lower monthly payment for the same car, than a loan can provide. You have not-so-good credit, since it is easier to get approved for a lease than a loan and there is often no requirement for a down payment (although there are usually "acquisition" fees for a lease) One fascinating aspect of a lease is that, under some circumstances, a car with a higher sticker price will actually have lower monthly payments. How? Since the payments are based on the difference between the selling price and the residual value, a higher-priced car may have a higher residual value that does not directly match an identical increase in the sticker price. For example, a basic, no-frills vehicle that costs $10,000 may have a residual value of only 49%, whereas the next model up (which includes better features) may cost $12,000 but have a residual value of 59%. The higher priced car will have a smaller difference between the price and the residual, which means lower monthly payments. This almost-magical effect of leasing is a prime reason for its popularity.

Driving many miles annually is often an argument used against choosing a lease, but this shouldn't defer you from considering one. If you are consistent in the number of miles you drive annually, the dealership can account for this in the contract. Yes, the monthly payments will rise but you will avoid paying excess fees when the lease is finished. Also, consider that mileage is the largest factor in reducing a trade-in's value, so even if you use a traditional loan you will ultimately pay for that mileage anyway.

The most confusing part of leasing is computing the monthly payment. The good news is that you need only a basic calculator to perform the math; a regular loan requires one that can perform amortized calculations. The bad news is that a lease's payments are based on the specific car that you are buying, including the sticker price and two numbers that only the leasing company knows: the residual value and the money factor (the interest rate applied to the lease which also includes administrative costs).

Tips for a Loan Maximize your down payment, which will minimize the amount you borrow and not only lower your monthly payments but will save you money by paying less interest Get a pre-approved and no-obligation loan from your bank or credit union before you go shopping. This gives you a negotiating tool to get the dealership to try to beat that interest rate. Tips for a Lease Make the minimum down payment necessary to meet your monthly payment budget; if the car is stolen or totaled in an accident, you lose your down payment because you don't have any equity in the car! Keep the length of the lease to no longer than the manufacturer's warranty, usually three years Be honest about the number of miles you drive, but avoid contracting for too many miles, since you do not get a refund for unused miles at the end of the lease.