Does Leasing Make Sense?
Auto sales in 2015 are on track to hit record levels not seen in 15 years. It’s estimated that sales will top 17 million units this year. The booming market has been fueled (pun intended) by the need for drivers to replace aging cars, historic low interest rates, and low fuel costs.(1) An often asked question is ‘what is the best way to buy a car? Should I buy a car outright or should I lease it?’ As a lifelong lessor, I am partial to leasing. However, before I impart my reasoning, let’s understand the basic difference.
If you buy a car and finance it with a bank, you will pay back the loan with interest over the timeframe of the loan. For example if a car is sold to you for $36,000 financed for 36 months, let’s assume the payment is $1000 a month. At the end of the terms, you will own a car worth roughly $18,000 and you can sell it…trade it or drive it off a cliff. It’s yours to decide how to proceed.
With a lease, you really don’t own the car. You are paying on a predetermined amount known as the residual value of the car. If we use the value of the example above of the car being worth $18,000 at the end of the three-year lease, you pay on that amount or $500 a month. However, at the end of lease, you own nothing. You turn the car back into the dealership and don’t have a car to trade or sell unless you purchase the car at the residual value of $18,000. You will also pay for any “excessive wear and tear” which could include excessively worn tires and abnormal scratches and dents. (2)
If you want to own something after the terms of the loan, then purchasing the car outright and taking an auto loan would be for you. However, if you like the idea of driving a car for just two to four years and then getting another new vehicle, then you may want to consider a lease.
When does a lease not work? If you like used cars, typically leasing doesn’t work well. The difference between the current value of a used car and its residual value at the end of the lease is not large enough to reap the rewards of the monthly savings you’d receive in a new vehicle lease.
Leasing is also not advantageous if you do a lot of driving. Most leases are priced with the vehicle being driven between 12-15,000 miles per year. If you exceed this mileage at the end of the lease, you will be nicked with paying 12-25 cents per mile you are over the aggregated mileage amount. For example if your mileage allotment was 15,000 per year and you have a three-year lease, you could not have driven more than 45,000 miles. If you drove 50,000 miles total during the lease timeframe, you’d pay for the 5,000 mile overage. If the penalty rate were 25 cents per mile, an additional $1,250 due when the car is turned in.
Leasing a car does not absolve you from insuring the vehicle for its full value. It also doesn’t absolve you from paying taxes on the full value of the vehicle either. The main reason to lease is you will pay substantially less than a traditional car loan in most cases. If you don’t like owning a depreciating asset and don’t drive more than 12-15,000 miles per year, it could make a lot of sense and might save you a lot of cents.