I’m going to take a break from the debt and philosophy of finance topics and share something a little more practical: buying vs. leasing cars. I didn’t always know what it meant to lease a car, so let’s start there. To lease is essentially to rent. Unlike housing, though, cars dramatically lose value over time, so the way it plays out is a bit different. When you strike a leasing deal with a dealer, you are agreeing to pay a smaller monthly payment (than if you were buying) for a specific amount of time, say two years. The dealer doesn’t need to get the full cost of the car out of you (hence the lower payment) because you are agreeing to give the car back at the end of the lease, at which point the dealer will sell the car at its current, 2-year-old market price. Since she is able to still sell the car, she only needs to get part of the cost of the car out of you. For this reason, when you lease a car, you need to think of it as belonging to the dealer, because it does. Just like anything you rent, any damage or use beyond what is expected or normal is going to come out of your pocket.
So Should You Lease?
This depends solely on your situation and preference. I prefer to buy a car and run it until its wheels fall off (my Corolla is currently over 250k miles), which means I have the same car for 15 or 20 years, most of the time with no payment. Many would prefer to have warranties, reliability, updates, and the latest models, all of which one gets when leasing. The more you agree with the following, the more leasing makes sense for you:
- You drive around 10,000 – 12,000 miles per year or less
- You prefer to have a car under warranty
- You prefer to have a car with the latest (but not fanciest) features, especially for safety
- You are comfortable with paying around $250/month indefinitely
- You keep cars clean and well-maintained (no young children, smoking, or messy pets)
- You use your car for business and can deduct car costs
- Your car of choice is one that has high resale value (trucks, SUVs, Hondas, Toyotas)
How To Lease
- Mind the Gap: Let’s say you sign a 2 year lease for a $20,000 car. The dealer is thinking she’ll be able to sell the car for about $15,000 when the lease is up. That $5k difference is what you are leasing (read: renting) the car for, split into 24 monthly payments (~$210/month). The old adage is that a car loses 20% when you drive it off the lot (which, if true, would take the value of the car down to $16,000 in a matter of minutes). Let’s say you drive the car off the icy lot and immediately into a tree. The insurance will pay the owner of the car (the dealer) the fair market value: $16,000. But you are still on the hook for that $5,000 difference between the new sale price and the 2 year, end-of-lease price. This is called “The Gap,” the difference between the car’s actual value and the agreed upon resale value – and you need insurance for it, appropriately called “Gap Insurance.”
- Put as little down as possible: Putting several hundred down at the start of the lease can lower your monthly payment, but remember that the car is not yours. Would you make a security deposit on an apartment if you knew you wouldn’t get it back? That is what you are doing with a down payment on a lease. You can offer to put extra money down as a security deposit, but not as a down payment. If you put money down, and for whatever reason, you don’t finish the lease (wreck the car, change your mind, etc.), then that money is lost. Heck, its lost even if you do finish the lease!
- Be careful about add-ons and upgrades: Let’s say the dealer talks you into adding an extra $1000 worth of features to the car (sunroof, navigation, bluetooth, stereo upgrade, and so on) for only an extra $40/month (1000 divided by 24 months). Remember that you don’t own the car. She just talked you into paying for upgrades for someone else’s car. When the lease is over, the dealer gets all those upgrades back. If you’re renting the car, you should rent its equipment, too. Include those features in the expected resale value so you don’t pay for 100% of them.
- Follow the warranty: Again, you don’t own the car, so you should pay for as little maintenance as possible. If your transmission locks up a month after the warranty, you have to pay for it before you give the car back to the dealer. Don’t sign a lease that extends beyond the car’s warranty.
I Don’t Mean to Scare You
These are just the main precautions you need to consider when leasing a car. Leasing is cheap on a monthly basis compared to buying, especially if you don’t care to keep the same car forever anyway. With just a few guidelines in place, your risk is limited and you can get a great car at a great price.