When looking at the options available for obtaining a new vehicle lease, rates often look pretty attractive. It seems as though you can get more car for a lower payment than if you were to purchase one with a loan.
But many in the finance sphere dismiss leasing as outright foolery. They espouse the idea that purchasing and holding until death is clearly always the least expensive way to own a car. Perhaps. But beware of those “always” claims. There are always exceptions.
Whether leasing a car or buying one is the better financial decision comes down to what you're trying to accomplish and how it fits into your goals, objectives, and budget. When making this significant financial decision, it’s important to understand how the options work.
Many people are familiar with the costs of financing a car. Far fewer really understand the costs of leasing. Financial literacy isn’t about being told what’s best for others — it’s about understanding what’s best for you.
Purchasing a Car
More people buy cars than lease them. And it’s simpler. Whether seeking new cars or used ones, you negotiate to the best of your ability, then either pay outright for the vehicle or take out a loan to help you pay for it.
New and late-model vehicles are big-ticket purchases. People tend to finance these over fairly long time periods. Whereas three- and four-year car loans used to be the norm, five- and six-year car loans are commonplace today.
Your costs when purchasing are clear and easy to determine. You have two sides of the transaction to consider. The first is what you pay for the car. You negotiate with a dealer or private party to determine the price you’ll pay for the vehicle and any allowance they will give you for a trade-in of your prior vehicle, if applicable. In many states, you have to pay tax on the purchase price — or net purchase price if you have a trade-in.
The second part of the purchase is how you’re going to pay for the vehicle. You may have a down payment, or you may use a trade-in as a down payment. You may finance through a bank or other financial institution that you select, or the dealership may secure financing for you.
Dealerships make a lot of money from financing. They may tell you that they don’t care where you finance, but they generally care very, very much. Be extremely careful. Shop around. Hopefully you work with a credit union, which is often where you will get the best rate.
Know that the dealership is not under legal obligation to give you the best rate it can. Quite the contrary.
Dealerships generally mark-up rates, charging you a higher rate than the financial institution approved you for. The financial institution pays the dealership for marking up the rate. They both make more money. The consumer gets screwed. Another day in the auto business.
Leasing a Car
A lease is a rental for a specific time period. Most people are familiar with leasing a house or an apartment. You sign an apartment lease, generally for a year, and the lease specifies your options at the end. For an apartment, the option is generally to continue on a monthly rental basis.
Auto leases are most commonly for a period of three years, but there are lots of variations. They're also for a specific number of miles. This is generally expressed as miles per year, although it’s only at the end of the lease that it matters if you go over.
You can generally select the mileage you need. Some manufacturers will do more than others. But you’re not typically restricted to the 10,000 or 12,000 per year they advertise.
Like an apartment lease, you can use the car for a period of time, and you have options at the end. Generally speaking, your choices are limited to returning the vehicle and buying it.
The costs of leasing a car are more complex than buying one, as there are more pieces. Most leases charge an acquisition fee, a cost for the manufacturer to lease you the vehicle. Many have a disposition fee, which is a fee the manufacturer charges you to end the lease. You have the amount they are charging you for the lease of the vehicle and, if applicable in your state, sales tax on the lease.
Leases tend to be advertised as a certain amount down and so much per month. The language is often misleading.
Much of the confusion — and I blame the industry — is due to specifying money “down” instead of “out of pocket.” These are not the same. A down payment on a lease is very similar to a down payment on a purchase. It is money you pay to reduce the amount you finance. In both cases, it lowers your monthly payment.
But zero down doesn’t mean zero out of pocket. There’s the acquisition fee, sales tax, and DMV or registration fees. These are often out-of-pocket expenses totaling several thousand dollars on a zero-down lease.
So you can respond to a zero-down lease, only to find that they want a lot of money. Not a transparent way to do business.
Sometimes they'll indicate the amount due at signing, which is often closer to your out-of-pocket amount. In this case, the variable is usually registration fees.
Other Financial Considerations
When leasing a vehicle, you're responsible for its maintenance and upkeep. You need to return it with only normal wear and tear, or the manufacturer will charge you for repairs. The simplest way to look at this is that the manufacturer wants to be able to sell the vehicle, and anything that detracts from that sales price is a potential problem. They even have standards for tire wear. Not kidding.
That said, a minor scratch probably won’t detract from what they can get for the vehicle, and hence won’t likely be an issue. A major scratch or a bit of a dent, and you have to pay to have it fixed. But the manufacturers will have a representative meet with you shortly before your lease is up, at your discretion. So you have a chance to go over the vehicle, and if something needs to be fixed, you can shop to have it done for a reasonable cost.
Keeping a vehicle that you've purchased is generally described as the most cost-effective way to use one. But as vehicles get up in years and miles, the costs of repairs and upkeep moves up dramatically. Vehicles eventually reach a point when it’s no longer cost effective to maintain them for daily use.
Plus, reliability goes down as vehicles age, which can be a problem if you need the vehicle to get to work, pick up the kids from school, or anything else that mandates we have a vehicle in the first place.
Differences in Lease Prices
Some vehicles appear to have far more reasonable lease prices than others. To determine the cost of leasing (renting) you the vehicle, the manufacturer estimates the value of the vehicle at the end of the lease. This is the vehicle’s residual value. This is generally the price they will sell you the vehicle for at the end of the lease. The difference between the price of the new vehicle and its residual price is the amount the manufacturer has to charge you for during the lease. Plus, of course, some sort of earnings on its capital and some profit.
But the higher the residual as a percentage of the new vehicle cost, the lower the payment. Vehicles that depreciate less cost less to lease. Some cars seem to depreciate a lot faster than others, and these tend to be more expensive to lease. Cars that hold their value well tend to be less expensive to lease. There can be large differences in cost between otherwise similar vehicles from different manufacturers.
Leasing vs. Buying a Car: Putting It All Together
Now that you have a handle on costs, you can do some comparison. What you’ll generally find is that in the shorter term, it’s less expensive to lease. And in the longer term, it’s less expensive to purchase. In your calculations, don’t forget that when purchasing, you end up with an asset; when leasing, you build nothing.
If you value having a new car every two or three years, and you don’t drive a crazy amount of miles, then leasing will tend to cost less than buying and replacing cars every couple of years.
If you’re willing and able to keep a car for an extended period of time, then you’ll likely pay less money to own a vehicle than you would spend if you lease several vehicles over the same period.
It isn’t that one option is better than the other. They’re different. Leasing works well for some people. They could spend less money driving a vehicle into the ground across a long period of time, but they wouldn’t be happy.
Some people are happy buying used up clunkers and stringing them along until they take their very last breath. If they’re mechanically inclined, they may do this very inexpensively. That doesn’t mean it’s a great way to take your kids across the country or even to their soccer games.
In order to know which is cheaper, you need to understand the options and doing the math. In order to know which is better, you need to understand yourself and your situation and what works best for you, considering what’s affordable. There isn't one correct answer for everyone, but there is one correct answer for you.