Is Leasing a Car Bad?

There are far too many people out there insisting that certain things are “bad” in every case. For example, some very prominent financial personalities will tell you that you should never lease a car. While car leases aren’t necessarily a great deal all of the time, neither is getting a regular car loan, or even buying a car for that matter. If you don’t know what you are doing, and work with people you can’t trust, you can get strung out in any number of ways during a car purchase. The lease isn’t the only potential problem

What Is a Lease?

So, what exactly is a car lease? When you lease a car, you change the mechanics of the standard auto loan, but at the end of the day, both processes are a way to borrow money to buy a car in exchange for monthly payments.

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When you buy a car using financing, you can either get an auto loan, or an auto lease. Most people are at least familiar with the basics of a car loan, so let’s start there and move onto how a lease works.

new car lease

Auto Loan

With an automotive loan, you take the purchase price of the car, and finance it over a specific period of time. For most people a “standard” car loan would be 60 payments, or a 5-year loan. 74 month car loans are getting more common as car prices get higher. You can even get an 86 month loan, although I would suggest that if you need that long of a loan term, you can’ actually afford the car you are buying.

In the make believe world, buying a car with an auto loan would be a function of the purchase price, plus taxes, divided into 60 equal payments, plus interest. In the real world, there are several other fees in there, and the interest rate varies widely depending upon a lot of factors including your credit score, where you get the financing from, and if the dealer gets any sort of kickback for the loan. At the end of the loan term, you have paid the entire cost of the car, plus interest, and you get to keep the car. It is now yours free and clear.

Auto Lease

With an auto lease, many of the functions are the same as buying the car. There is still interest, although they may call it something else. The cost of the loan varies upon many factors including any fees, and the interest rate you get. So far, nothing is different from an auto loan.

The main difference with a lease is that instead of paying for all of the purchase cost of the car, down to zero, you pay for only the cost of some of the car.

So, if you buy a $50,000 with an auto loan, you pay $50,000 plus interest.

If you lease a $50,000 car, you maybe pay $20,000, but after two years, you give the car back.

In the above example, the residual value (or the value left in the car after you are done leasing it) would be $30,000. In other words, the leasing company is making a bet (actually an educated guess) that the car you are buying for $50,000 today, will be worth $30,000 in two years. Thus you just pay the difference.

Now, just like with the loan, there are some fees to consider. The biggest one is usually a mileage fee. One way to keep the cost of a lease down is reduce the amount of miles you are allowed to put on the car. After all, a $50,000 car with 40,000 miles in two years, will be worth less than the same car with only 10,000 miles. If you don’t understand this, you can be hit with a pretty big shock at the end of the lease, because the way they make this work is that you owe an extra amount for ever mile over your lease.

The important thing to remember here is that this is not a scam. You paid less for two years, and now you owe more at the end. Overall, beginning to end, the overall cost might be similar. (Usually, the leases charges a pretty high per mile rate, so you won’t come out even, but it isn’t crazy either. Remember you get no refund though if you don’t use all your allowed mileage either.) All of these kinds of things workin in favor of the leasing company helps cover their primary risk.

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When they lease you the car, they make a (educated) guess at what the car will be worth in 3 years, or 2 years, or whatever. If they are too high, they lose money, so they usually guess pretty low.

You Don’t Get The Car But You Don’t Spend the Money Either

The biggest thing people get caught up on with a car lease is that you don’t get the car at the end of it. That is true, but you also did not pay for the whole car. This is the whole point.

To understand, it helps to think of it from a net worth perspective.

Just to make things simple, we are going to pretend there is no interest.

If you buy the car with a regular loan, over the course of five years you have paid $50,000. You now own a car worth $15,000. Your net worth for this transaction is -$35,000.

If you lease the car for two years, and there is a $30,000 residual value, then over two years, you paid $20,000. At the end you do not own the car. Your net worth for this transaction is -$20,000.

Now, this isn’t a straight comparison, because you have to find a different car for three years to make this even over a time period, but the point is that while you don’t own the car, you also paid much less for the car you don’t own.

As with most things in money and personal finance, knowing exactly what you are doing will save you much more money than blindly following generic advice. – My advice (take it or leave it) is to find a car broker that you trust. How do you know you can trust them?

Ask to look over their shoulder as they use the computer to find your loan and lease terms. They should not only let you, they should be willing to explain what each of the numbers mean and how each of the varying terms affects your particular situation. Once you have figured out your financing, finding the car just takes a few phone calls.

 

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