Used Car Buying Tips - Part 6: Lease Or Buy?

Technically, this is not a “used car” topic, but I will still present it as a part of the series because it’s one of the common questions faced by people who are looking for a car - used or new. Even if they are in the market for used cars, they will spend a few hours toying with the idea of getting a car on a lease - because of the lure of low monthly payments.

In extremely simple terms, when you lease a car, you are simply paying for the depreciation, instead of paying to own the car. Obviously, it follows that, over a given period of time - say 36 months - it takes lower monthly payments to account for just the depreciation instead of accounting for the total cost of the car.

However, the “lower monthly payments” pitch that goes with all the lease advertisements is a bit deceptive … especially, if you anticipate yourself to be a long term car user [which is *generally* the case in the US].

To really understand the cost of leasing cars, one should look beyond just the monthly payments and calculate the total out of pocket cost over the entire term of the lease ~ and also extend some numbers to a longer time frame.

Towards that kind of understanding, let’s run a quick example (with some simplifying assumptions). A typical lease offer is quoted below (edited to retain only the relevant information):

2007 Accord 4-cylinder Sedan LX Automatic Transmission for $199.00 per month for 36 months with a $1,999.00 capitalized cost reduction available … $2,793.00 total due at lease signing (includes first month’s payment, security deposit, upfront acquisition fee and capitalized cost reduction; total net capitalized cost and base monthly payment does not include tax, license, title, registration, documentation fees, options, insurance and the like)

MSRP $21,520.00 less the capitalized cost reduction resulting in actual net capitalized cost $18,072.93. Taxes, license, title fees, options and insurance extra. Total monthly payments $7,164.00. Option to purchase at lease end $12,481.60.

In this example, the total out of pocket cost over the length of the lease is calculated as follows

• Total monthly payments = $7,164.00 (this is simply $199 multiplied by 36 months)

• Amount due at lease signing= $2,793.00 (down payment)

• Less refundable security deposit (approx) = $200.00 (included in the down payment)

• Less first month’s payment = $199.00 (included in the down payment)

• Total cost at the end of lease = $9,558

Now, you can compare this number with the anticipated depreciation (over the first 36 months) for this particular make/model:

[source: Edmunds.com]

From this image, you can see that the depreciation over the term of the lease (36 months) is = $3,716 + $2,178 + $1,917 = $7,881.

Apparently, with the lease payments, you are paying way more than just the depreciation. The extra cost over depreciation can be considered as the cost of the availing this leasing facility [analogous to the cost of interest in case of an auto loan].

If you are looking for a car for only 3 years, and have sufficient cash, you will be better off by paying for the car upfront and then selling it yourself after 3 years. That way you will (ideally) only lose the amount that goes with the depreciation (which is much less than the leasing costs).

Now, consider a much longer time span - say 12 years. In this period, you will have to avail four leases with each costing you approximately $9,558 (assuming that the make/model/price stays the same - this is a bad assumption, but it’s still on a conservative side) - this will lead to a total cost of $38,232 over 12 years just for the depreciation - and at the end of that many years, you still won’t be owning a car.

Instead, if you had purchased the same car by putting the same down payment (MSRP $21520, $2793 down, 6% APR for 60 months), you would have paid a total of $24,515 to own the car. And, that car would last you about 12 years (if you maintain it properly) without the need for a replacement - at that time it will also carry some residual value, even if it’s just a little more than peanuts. Obviously, leasing is not economical in the long term. And if you are like most Americans who will probably drive cars for more than half their lives, then you will need to look beyond leasing options (unless of course, you can afford to keep leasing).

Plus, you also need to consider that most lease offers come with additional headaches like mileage restrictions, penalty for getting out of lease earlier than the original lease span, disposition fees (these are fees to cover the cost that the leasing agency will incur in selling the vehicle after you return it), etc. Another (bigger) headache can be caused by the trouble you will face if you damage a leased vehicle. The leasing agency will want all the damaged parts to be replaced by OEM (original equipment manufacturer) parts and most insurance companies will provide compensation only for after-market parts - and you might have to shell the difference (OEM parts are, at times, more than twice as expensive as after-market parts).

In spite of all this, there are situations where you stand to gain from good lease offers.

In the above example, there is a clause that says:

Option to purchase at lease end $12,481.60

If you add this to the cost of lease ($9558), you end up with the total cost of the car as $22039.60. This is much less than what you would have paid for it if you had financed it over the 60 month loan ($24,515). Therefore, in cases where you are anticipating to save enough cash over the next couple of years to purchase the car at the end of the lease period, you might save some money by opting for the lease option.

So, give it some thought before you make up your mind in favor of (or against) a lease offer in future. Always compare the total cost of the leasing to the total cost of financing.

By the way, a reader “car girl” asked a question on the first post in this series about car buying tips:

Can you talk about leasing? I’m wondering about a 3 yr lease for my grad student son. Pluses and minuses?

Apart from the money aspects that I talked about, you should also consider the fact that leased cars require the users to follow the factory prescribed scheduled maintenance (to keep things in good shape). If that is not done properly, then you are looking at some penalties when the lease ends (plus there are penalties for excess mileage). Now, I mix and mingle with many fellow graduate students every day and I know how they use and maintain their cars. Based on that, personally, I won’t be very upbeat about letting them drive a leased car. So my advice to car girl is to go ahead with the leasing idea only if she thinks her son can take regular good care of the car.

Resources: The Federal Reserve Board has some excellent information for consumers interested in knowing more about leasing vehicles. The information appears as a part of a “comprehensive consumer guide” titled “Keys to Vehicle Leasing“. Below, I am highlighting two parts of this guide which every shopper, interested in leasing, must read:

• Shopping Tools - Lease Ads: all lease offers will use jargon like “capitalized cost reduction” and will throw a bunch of numbers at you. This page will give you details on how to understand such terms and costs mentioned in lease ads that are usually seen in print and digital media.

• Guide for Educators: there are some easy-to-understand presentations on leasing fundamentals on this page. Go ahead and download those for your reference in future.

Note: for the examples in the post, the differences in the costs (lease vs. buy) of tax, title, licenses, maintenance, insurance, and other small fees have been ignored in favor of simplification.