Have you ever watched a new car commercial that boasts a super low monthly payment, with a big asterisk next to the price? Car companies are quick to tempt viewers with low monthly payments when it comes to their three year leases. It is easy to think, “Hey, I’m an adult now, I need a new ride, and that offer is cheap without much commitment.” Before you sign your name on the dotted line though, find out the truth behind car leases.
Is leasing a car really better than owning for college students and graduates on a tight budget?
What is a Car Lease?
First let’s start off by covering what a car lease actually is. 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 three or five years), at which point the vehicle must be returned to the dealer, or an agreement to purchase the vehicle must be in place.
Leasing is a popular way to finance a new car because of the promise of lower monthly payments. Taking on a lease means that you get a new car for a set amount of time without having to pay the huge sticker price up front. But, of course, there is a catch.
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.
And if there was any confusion, when you lease a car, you give it back after the agreed upon amount of time. You don’t get a trade-in bonus or some cash back in your pocket.
Basically, leasing a car is like renting an apartment with a strict landlord. He charges you for your rent, and then charges you a fee if you go over your utilities usage allowance, and once you move out, he refuses to give you your deposit back because of some tiny scratches on the wall.
Which Is Better for College Students: Leasing or Buying?
Buying a car is more of a financial commitment because you are stuck with that huge sticker price upfront. You can either pay for your car purchase with cash or by financing it with a loan. Your loan rate, if you get one, is determined by your personal credit history (good credit will get you a good rate).
You don’t have to keep your miles in check or worry about wear and tear. You can drive and treat your car however you like once you own it, because it is all yours. Of course, how you maintain your car will either benefit or hurt you when it comes time to sell it or trade it in.
That leads us to the important benefit of buying a car. Since you bought it, you can then sell it or trade it in. Say you pay off your car loan in five years, but decide you want to get a different vehicle. You now have a vehicle of value to sell yourself or to trade-in at the dealership and qualify for trade-in bonuses.
The downside to selling your vehicle is that you will not get back how much you bought it for. In fact, you may notice that your new vehicle depreciated quite a bit in the first few years.
That brings us to why people lease cars in the first place. Depreciation on new vehicles is quite dramatic. Many car buyers will avoid the depreciation by leasing a new car instead.
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. For certain individuals, leasing also allows you to write your car off for business reasons.
The short-term cost of leasing is always cheaper than buying, by about 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.
How to Get the Best Deal on a Lease
If you are set on leasing a new vehicle, then there are some tactics you can use to get the best leasing deal at the dealership.
- Research: Spend some time doing research. Just because you aren’t going to own the car after the least does not mean that you shouldn’t put in a few hours to look up the best car for you, as well as the leasing trends on Consumer Reports. Also, knowing the Kelley Blue Book value of the vehicle before you buy can help you ensure the dealer is not artificially inflating the car’s sticker price.
- Negotiate Separately: When you go into the dealership, don’t make it known whether you are buying or leasing the car. You want to negotiate the car’s actual price down, and then negotiate the lease terms separately.
- Know the Hidden Costs: Lease agreements can have a lot of hidden costs. It is wise to get a copy of a lease agreement to take home and study before ever striking a deal. Make sure you also know and prepare for any extra fees and charges. For example, you can expect a startup fee, document charges, security deposit, and additional fees for extra miles used or extra wear and tear to the car.
- Closed-End Leases: Make sure to only opt for close-end leases to save money. An open-end lease may have extra requirements attached, such as buying the car afterwards or paying for other expenses.
- Know the Residual Value: The residual value of your car is what the car will be worth the day you return it. Vehicles that hold their value the best are ones that are going to be the most affordable to lease.
My Personal Car Buying 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.
Should You Lease A Car or Not?
For a select few, leasing may be a good option. Leasing is an option for those who wish to get a new car every few years or who can write it off for tax reasons. Of course, getting a new car every few years is not financially sound, but if that is what you want to do, then leasing is better for you. However, for those who want to save money and to invest in a car long-term, leasing is not the way to go.
Dealers are prone to making leases look like a better deal, but let’s get real here. 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 lessee usually ends up paying more than the depreciation on the car, and that difference goes right into the dealer’s pocket.
Ultimately, the decision comes down to you. If you want to avoid costly depreciation costs, then research buying a used car instead.
Readers, do you think that leasing a car is a bad financial move?
Robert Farrington is America’s Millennial Money Expert® and America’s Student Loan Debt Expert™, and the founder of The College Investor, a personal finance site dedicated to helping millennials escape student loan debt to start investing and building wealth for the future. You can learn more about him on the About Page, or on his personal site RobertFarrington.com.
He regularly writes about investing, student loan debt, and general personal finance topics geared towards anyone wanting to earn more, get out of debt, and start building wealth for the future.
He has been quoted in major publications including the New York Times, Washington Post, Fox, ABC, NBC, and more. He is also a regular contributor to Forbes.