You may have heard this before, but in most cases, leasing a car is a bad financial move for individuals. This may be controversial, but from a personal finance point-of-view, leasing is not the best option.
What is a Car Lease
First, a car lease is the right to use a vehicle for a set amount of time for a set cost, determined by the lease agreement. It is commonly offered by car dealers as an alternative to purchasing a car. A lease usually has a set term (such as 3 or 5 years), at which point the vehicle must be returned to the dealer, or an agreement to purchase the vehicle must be in place.
Lease agreements usually have a lot of stipulations, such as an early termination fee and a limit on the number of miles that can be driven. The most common mileage amount for a lease is 10,000 miles, and if exceeded, additional mileage charges will apply at a pretty high rate (usually $0.20 per mile). You can typically negotiate a higher mileage amount, although it will increase the cost of the lease. You also can be charged a fee if there is any excess wear and tear, or damage that was done to the vehicle. You can learn some great negotiating tactics here.
Lease versus Purchase
When you buy a car, you pay for the entire cost of the car upfront, or with a car loan. You typically pay cash, or a down payment, and then take out a loan. Your loan rate, if you get one, is determined by your personal credit history (good credit will get you a good rate). Later, if you decide to sell the vehicle, you can for whatever price you want, given the market value. You will still owe your loan amount if you have one.
When you lease a car, the premise is that you are paying for the depreciation that you incur during the lease period. Lease payments are similar to a loan, except that you pay sales tax and a money factor (which is like an interest rate, but not truly an interest rate). You must also usually pay a security fee and still prove you have good credit.
Time Consideration
The short-term cost of leasing is always cheaper than buying, by abut 30%. This is because your lease payments are usually lower than your loan payments if you have a loan. Also, depreciation of a car is always the most in the first year.
In the medium-term, 2-4 years, leasing and buying costs are about the same. The costs here really depend on how good a purchase deal you got on your car, and if you have a loan or not. If you got a steal on a new car, and paid cash, chances are your break-even versus a lease will be about 2 years. If you didn’t get a good deal, or have a high-interest rate loan, your break-even could be even longer.
In the long-term, leasing is ALWAYS more expensive than buying. There will come a point, in the very long term, however, when the cost of maintenance will exceed the cost of the car.
Personal Story
My wife’s car is about 4 years old. We purchased it for $20,000 brand new. We recently went to CarMax to see what it would sell for. They made us an offer for $11,000. So, in 4 years, the depreciation of $9,000 would have been $187.50 per month. The best lease at the time was around $199 per month, and it had low mileage limits.
Now, as we continue to own the car, it was an even better choice to buy, as the largest amount of annual depreciation has already taken place.
Final Thoughts
My final thought is: would dealers really offer a lease if it didn’t make them money? Dealers profit on the lease from both the payments made on the vehicle and from reselling the vehicle once it is turned in. The lessor usually ends up paying more than the depreciation on the car, and that difference goes right into the dealers pocket.
Second, if you want to get a new car every 3 years, you are not being financially smart, but if it is what you enjoy, then more power to you.
Finally, nothing I said applies to businesses, who do have a legitimate reason to lease a vehicle.
Readers, do you think that leasing a car is a bad financial move?
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This post was written by...
Robert – who has written 317 posts on The College Investor.
Robert is the founder and editor of The College Investor, a personal finance site dedicated to young adult and college student finances. You can learn more about him here and connect with him on Twitter or Facebook.
{ 11 comments… read them below or add one }
The lessors are definitely profiting on these vehicle leases.
I used to manage a corporate fleet of vehicles for my company and we had open-end leases as opposed to the closed-end leases consumers have. Essentially, instead of the mileage restrictions, we were responsible for the difference in the book value and selling price of the vehicle. It wasn’t often a vehicle would sell for less than the book value unless it was damaged.
Very interesting insights. Good reason on why buying and reselling is better than leasing.
Totally agree! Leasing is a losing proposition. Even if you want to drive the latest and the greatest, it may prove more cost effective to sell and buy the latest.
Leasing is a great deal for the dealer though!
I agree with moneycone it just doesn’t make sense and even then cars are one of hte worst assets to have since they depreciate so fast.
-Ravi Gupta
I once heard leasing is like renting. The best deal would be paying cash and holding on to it forever. I am close since my cars are 16 and 14 years old.
@Dave, thanks for sharing your first hand experience! I knew that was a practice, but I have never heard it directly before!
I never lease a car since it seems like such a bad deal to me. I don’t mind driving an older car as long as it’s safe. I don’t need a brand new vehicle every few years so leasing doesn’t make financial sense to me.
Buy a cheap used car. That’s what I tell my clients all the time.
I agree on leasing, and have never leased a car for these reasons. Let’s put it this way: my last car was driven to over 220,000 miles. I’m definitely not the 3 years and replace it type of person. While I really like newer cars and nice cars in particular, I like saving money better. It’s as simple as that!
@Squirrelers – Over 220,000 miles! That’s huge!
i think you guys need to think about the length of ownership and maintenance costs. We are leasing a Jetta because we don’t plan on owning the thing in 5 years. I basically calculated the length of ownership vs. potential depreciation and cost of buying a 1-2 year old car vs. the potential depreciation of that used car. Depending on what car of course, I figured it would be close to a breakeven on leasing vs. buying and then owning a 1-2 year old car your depreciation is about the same because the cost of used cars is so high right now. Also, the Jetta will probably start falling apart around 4-5 years and we don’t want to deal with that.
Again, I think it all comes back to length of ownership/lease and whether or not you want a brand new car…under 5 years, lease may be a better option…no one wants to go upside down on a car