If you’ve ever gone car shopping, you may have come across the option to lease a new car.
On the surface, a car lease seems too good to be true. You get to drive home in a brand new car for a lower monthly payment than if you got a loan to buy the car. Then, in two or three years, you have the option of buying out the lease and keeping the car or trading in for another new car. What’s not to like? Why wouldn’t it better better to lease?
Car leases are a subject of great passion for a number of financial writers. Ask these guys whether it’s better to buy or lease a car, and most will look you straight in the eye and say: “never ever lease a car!”
In most cases, I agree. But not always. (More on that to come.)
So why do most people agree that it’s better to buy rather than lease? The logic behind the conventional wisdom is simple: When you lease a car, you don’t own it. You have no equity. Your monthly payments disappear.
OK. So what? Who needs to own a car? What if you just want to drive it, not worry about maintenance or ownership, and just pay for that luxury?
If that’s how you feel, then leases will be attractive. You must simply realize that:
- Car leases are a luxury and
- you will pay for that luxury.
I can recommend leasing to somebody who is debt-free, financially successful, and can afford the luxury. Perhaps that person is savvy enough to know that by investing money she would’ve spent on a car, she may come out ahead when that money earns a good return in the stock market. (Here’s a calculator from SmartMoney.com to help you figure that out.)
Over the long run, it is more expensive to lease a car than to buy one. The only way you can change this calculus is if you buy a new car and trade it in every three years or so, in which case leasing may save money. (But realize that by buying new and trading in frequently you are burning up TONS of money, too.)
Also, a lack of equity is only one downside to a lease. Let’s look at the other pros and cons of car lease:
The Upside to Leasing
Brand New Car: Leasing is about luxury and convenience. You get the luxury of a new car and the convenience of not having to worry about maintenance. That’s not to say you can go two years without an oil change, but because the car is new, you hopefully won’t have to worry about any major repairs.
Lower Monthly Payment: In most cases, the monthly payments on a lease are less than if you get a loan to buy the car at normal interest rates over three or four years. Keep in mind that most leases do require down payments equivalent to those required if you’re going to buy.
The Downside to Leasing
No Equity: As I mentioned above, you never own anything when you lease. Although leasing may seem less expensive over the next two years, in the long run you’re going to pay because you’ll always have a monthly payment.
Mileage Limitations: If you drive a lot, a lease is not for you. Dealers make money on leases because they collect your lease payments and then can resell the car as a two or three-year old certified used car. But the more miles on the car when you turn it in, the less a dealer can sell it for. Most car leases will charge something like 12 cents for each mile you drive over a certain limit. Most leases set a cap between 12,000 to 15,000 miles per year.
Excellent Credit Needed: Leases require top-notch credit. Although you can get a car loan even with bad credit, that’s not the case with a lease.
No Damage or Customization: The dealer will charge you for any excessive wear-and-tear on the leased car when you turn it in. That means dents or dings or interior damage from smoking or pets. It also means you can’t customize a leased car.
It Can Be Hard To Get Out of a Lease: If you buy a car and six months later lose your job, you always have the option of selling it.
With a lease, it’s more difficult. You can’t just end the lease early…at least not without harming your credit. Some sites like Lease Trader have created networks to broker a secondary market for leases, but it’s a limited market, so don’t count on having the option.
It’s Complicated: Understanding how leases are priced is more complicated than understanding a sale. I didn’t even fully understand them when I worked at a car dealership and I was selling them!
Lease prices depend, in part, on:
- Capitalized cost — similar to the initial price of the vehicle.
- Mileage allowance
- Your credit
- Money factor — This is the confusing one. The money factor is similar to an interest rate; the lower, the better. A lease money factor is a very small number such as .00315. Multiply the money factor by 2,400 to get something you can understand as an interest rate. In this example, 7.5%.
- Residual Value — The car’s value at the end of the lease. A higher residual value can lower your monthly payments, but make it harder to get out of the lease if needed. A lower residual value means higher monthly payments but a lower buy-out option at the end. This will also make it easier to sell the lease or trade-in the lease mid-term.
Lease or Buy: How to Decide
When it doubt, buy, don’t lease, your next car. Keep in mind that according to Cars.com, 80 percent of people buy their cars. You won’t be alone.
Used cars make the most financial sense, but if you must buy new, commit to owning the car as long as you can. There are a few exceptions:
- If you’re debt-free, successful, and like the idea of a new car with minimal maintenance and are able and willing to pay for that convenience. In other words, know what you’re getting into. It’s all about conscious spending. If you have the money and spending it on a car lease makes you happy, go for it.
- If you plan on investing a lump sum of cash that you would’ve spent on the car.
- If you use your car for business and deduct car depreciation as a business expense, leasing may make more sense than buying. Consult your tax advisor first.
Before you leave your opinions on the buy or lease debate in the comments (and I hope you do), remember there are always exceptions. Maybe, for example, you only need a car for two years and don’t want to worry about selling it when you’re done. And in some cases, in-demand used cars are worth so much at the end of a lease, lessees actually come out ahead! (Don’t count on it though.)
So…what say you? Do you think it’s better to buy or lease a car? Let us know in a comment.