A friend of mine recently started having car problems. Her car was old and it is time to get a new(er) one. Being the person who obsesses about finances, she asked me what kind of car she should get. The questions didn’t stop there. Next, she asked me whether she should buy a car or lease one. While I would love to say that I knew the answer for her right away, it just wasn’t the case. To be completely honest, I didn’t even know that much about leasing a car – mainly because my parents never leased a car. They always bought the cars, thereby leaving me with a gap in understanding.
Why do people lease cars when they can buy them? Is it better to lease a car? Is it better to buy one?
As I suspected, there is no easy answer, but I do hope to shed some light on the basics of leasing a car and when it is better than buying your own car. While I am still against financing cars, I know that not everyone has this luxury and leasing or buying a car with financing might be someone’s only option.
How to Lease a Car – Basics of Car Leasing
After doing some basic research with my friend Google, I found a great article about leasing a car. This form of getting a car is actually quite a simple concept. The idea is that instead of buying a car (either with financing or cash), you are renting a car. In other words, a third party buys the car (usually a bank) and allows you to use the car for a monthly payment (and down payment). You general lease a car for a set number of months, ranging from 2-5 years. You agree to take care of the car, performing and paying for regular maintenance and return the car at the end of the lease. As I have been told, some (if not all) leases have the option of buying the car at the end of the contract.
Benefits of Leasing a Car
While leasing a car may not be for everyone, it does have its benefits. As I can tell, leasing a car gives you the advantage of not having to worry about selling the car after a few years. This may not sound like a lot, but for those who are strapped for cash, this may be an answer to prayer. Otherwise, imagine this. You want to upgrade your car and you have some cash to buy the next car. In order to keep your cash reserves in place, it means selling your current car. But, you can’t just sell your car without a new one. Often, it means that you buy a car, scrape buy for a few months while hoping and praying that you sell the car. This can be stressful as any other financial challenge.
Another benefit of leasing a car is that you can drive a new car for less than it would cost to buy it. Leasing a car is generally lower than the monthly payment to purchase (even though it means you will always have a car payment – if you keep leasing). Not only is it generally lower, but it also means that you don’t have to worry about whether you will owe more than the car is worth.
Last, but certainly not least, leasing a car means that you are driving a new car. With that, the odds of having to deal with car repairs is significantly lower. As a general rule, you don’t have to worry about major repairs. As we all know, dealing with major repairs can be expensive and time-consuming.
Why Leasing a Car Could Cost More
While leasing has its advantages, it isn’t without it’s downsides. While my friend is convinced that leasing is the best option for her at this point in her life (and apparently 20% of Americans as 1 out of 5 cars is leased), I am not entirely convinced. The best way that I have found to determine whether it is the best financial option is to estimate the total costs per year. Let me give you an example.
If I can buy a new car for $20,000, in two years, it will be worth approximately 14,500 (assuming 15% deflation rate each year). Assuming I can either find 0% financing or pay cash, that means I am spending $2750 each year plus gas and maintenance. Let’s imagine that I can lease the same car for 2500 down at signing and $200 per month. A 24 month lease would mean that I am paying $4,800 in monthly payments in addition to the $2500 down. $200 per month for a new car may sound like a great deal, but it really means I would be paying $7,300 for the two years or $3650 each year plus gas and maintenance.
This was only an example used to illustrate the calculation, but the key is that deflation or the value of the car at the time of selling the car is often over-looked. Instead, people often place emphasis on the short-term costs (monthly payments) instead of the long-term costs. Since you are still responsible for maintenance, I would guess that leasing a car is often more expensive than buying (but I would have to do more research).
Buying or leasing a new car may not be the best options to choose from (I prefer to buy a used car because it’s value depreciates slower). Yet, when forced to choose between the two, I will side with buying a car over leasing because I have the cash reserves to not stress about selling the car in a short period of time. Everyone else may not have the time or money to save by buying a car, and therefore leasing may be the better option.
Have you leased a car before? What was the deciding factor?
I think this one is tricky — if you know that you only want to drive a car for three years, then fine, you’ll get used to the car payment, you’ll always have one, and it’s no big deal. For me, it’s not worth it because I don’t want to buy a new car until my current car sputters its last breath, which will likely be five to ten years from now.
I don’t mean to sound like a grumpy old blogger, but after the first two sentences I knew that your friend was going to waste money. “A friend of mine recently started having car problems. Her car was old and it is time to get a new(er) one.” If you just recently started having car problems, that is no reason to get a new car. And what qualifies as “older”? I think it might be better to help her find a good mechanic that won’t rip her off, or maybe she knows someone with a little car maintenance experience who can keep her car running?
I would just qualify her situation a little more rather than just agreeing she needs a new car. It’s weird, we don’t do this with other things that need maintenance, example “My plant keeps needing water, I need a new one” or “My bike has a flat tire, I need a new bike’ or “My house is dirty, I think I need a new one”. I believe that people are scared of cars because they don’t understand them at all, so when there is a perceived issue they deem it “unreliable” and look for a new one. This works with clothes or tools but should not be this way with something that costs tens of thousands of dollars everytime it’s replaced.
tl;dr Cars should be maintained, not replaced. New does not always mean reliable. People should not buy something they don’t understand. I’m not saying you need to know how to replace the tranmission, but at least know what maintenance is needed to kep the car going besides your oil changes. 20 seconds on the internet could save tens of thousands of dollar, heck maybe even hundreds of thousands over her lifetime.
/rant
Sorry about that, but I have a certain passion for this topic. I’m not saying you did anything wrong, and she may well need a new car, but I would venture to guess that most people that buy new(er) cars don’t. My $0.02. 🙂
haha – great comment. It’s moments like these that I wonder how much you and I are alike. About two weeks after I wrote this (about a week ago), I talked to her and told her that I think she should just get her car fixed. 🙂 I told her that even if she had to pay $2k to fix it, it would be much cheaper to do that and have it last another 2-3 years than lease a car. Short answer, I couldn’t agree more with you. I think that’s a great analogy about having to buy new cars, but not anything else, btw.
Haha, that’s perfect! I just get fired up about the “buying a new car” topics. It’s the one place I feel like people can save tons of coin, but elect to waste it because they haven’t done any research! Nice work on suggesting to fix instead of replace. We must be brothers from another mother, LoL! When I first started reading PF blogs, I saw your and was like “that’s totally me.” No joke. Maybe because I’m in my “20’s” and love personal “finance” 😉
Hey Corey! We’re on team 6 together with the Yakezie teams.
Anyway. My mom used to lease cars and I always wondered why. At the end of the term, she’d have spent a lot of money on the car but didn’t have anything to show for it. I think she financed her current car, and I did the same with mine – at least I own it at the end of the term!
My preferred method is to pay cash for a nice used car. My wife and I made a commitment to drive our cars to at least 250,000 miles while saving what we used to spend in car payments every month. When her previous car hit 250k it still ran very well, but we had $20,000 to spend on a killer used Infiniti that someone else had leased and had nothing to show for all that money they had spent.
Financing a car with a loan or lease ALWAYS means that you pay much more than if you had paid cash, and that extra you’re paying is for a depreciating item to boot.
We will never go back to having a car payment again. I wrote a post detailing how we did it a few months ago that you may be interested in.
4 Steps to Getting Rid of Car Payments Forever http://wp.me/p1yqwF-8Y
leasing is icky.. the upfront costs are just absurd, considering that you really don’t get any return on your value.
i have always bought and presumably always will. it sure would be nice to pay with cash tho!
I think if you want to drive a new car all the time, then leasing might be a good option. We drive our cars into the ground though so I don’t think the number works out for u.
Thank you for this! I’m the market for a new car (my car is 17 years old and not quite chuggging along like she used to). I was weighing the pros and cons of leasing, and this was a great article.
I think its also important to point out that some dealers offer incredible incentives to purchase a vehicle. There are military and college rebates (anywhere from $400-$1000 off the price in addition to other current rebates) that are only applicable to purchased cars, not leased. Some manufacturers offer enticing warranties that make those looming future auto repairs not so scary. Hyundai has the 10-year/100,000 mile warranty. Unless you travel cross-country via car on a regular basis, you’re nearly guaranteed a solid three years of cost-free maintenance (hopefully, its more like 10 years though).
If you can afford to pay for a car in full, surely it is ALWAYS better to pay for a car than lease it? I just can’t see how the maths works out.
What does better mean? It is like you didn’t read the middle part of the post where it says that getting a new car is of value to some people.
I’ve never financed or leased a car, but my accountant is advising me to lease as car for my business. Does it make any sense to pay the entire lease off when I pick up the car?
Sure it looks like the dealer paid it, but every deler gets in back in
their monthly advertising allowance on each new vehicle
they have in stock. Not to forget the ease with which you travel; you are completely free too strop wherever and whenever you want.
A smaller car, it is still expected to pick up some buyers who would have gone with Toyota or Mazda.
My son graduated in May and started his first teaching job and we’ve been busy helping him get into his apartment and just yesterday with getting a car because his old BMW just needs too much work. My mechanic called me in the morning to yell at me before he even had a price telling me that I need to get rid of that car already even though he loves me giving him tons of money to fix it. My son leased because with starting a new job in a new city with a new apartment, money reserves were low and his expenses are a complete unknown so we needed to keep the initial outlay of money to a minimum and keep his monthly payments as low as possible. We couldn’t even trade in his old BMW. Should he have been saving as much money as possible prior to this – yes he should have but with paying for school and rent and maintenance on his old car, and everything else, that was not easy to do.
Here’s my opinion after years of buying new, used, and leasing new cars.
Buy with cash: I think the best approach is buy your car, new or used, with cash. I’ve not been able to do that since I bought my first used cars for around $500 in the mid 80’s (actually I just bought a classic with cash a few years ago). Also, you may actually not get the best deals buying with case (so I’ve heard) because the companies want you to finance the car. Buying new means instant depreciation so why not just buy a one or two year old car – or even older as long as you have a mechanic check it out. Having a mechanic check it out is ideal but often pricey and logistically difficult and I’ve not actually ever done it but it is a good idea.
Financing new: put down a large down payment and don’t finance for more than than 5 years. Maintain the car properly. Plan on keeping the car for a long time. Your payments will obviously be higher than leasing but if you can afford it, maybe this will work. I’ve done it a couple times but it seems that cars are just getting much more expensive and it pushes the monthly payment much higher than I’m comfortable with.
Financing used: pretty much the same as new – look for loans from credit unions for low rates. Get an extended warranty from a reputable company – lot of crooks out there but I’ve had great experiences with the 2 I’ve had so far.
I’ve always wanted “financing used” to work but it just seems to be not a great deal but maybe I just pick bad used cars. If you finance a 3 year old car for 5 years, at the end you have an 8 year old car that probably has no extended warranty on it and while your maintenance costs per year might not be that high, depending on the car, they will likely start to increase. A car with 100k or more really starts to need a lot of parts – shocks, struts, engine and tran work, etc etc. Expensive european cars are the worst with this – they are expensive to maintain to begin with and even more expensive to fix when things start going wrong.
Leasing works really well for me and my family because we live in an area where we drive short distances for anything we need and don’t have a problem with mileage limits. I’ve heard people complaining about how much it costs to get out of a lease – if you are getting out of the lease because you don’t like the car, just suck it up and live with it. If its because of financial hardship, then try to work with the leasing company. I’ve also do little to no down payment (cap cost reduction) because its basically pointless on a lease – its really just prepaying the rent to reduce your monthly payment.
Buying out a lease is something that I’m not sure is a great idea – I have mixed feelings. I bought out the lease on my large SUV because we liked the car and buying it out was actually a better deal than anything else we could find because they were always less car for more money. However to keep the payments down, I’ve financed it for 6 years so I’ve now been paying for this car for 8 years (1 to go) and I now have a car with over 100k miles that is 8 years old (9 when I’m doing paying for it) so I’m starting to question how much more life it really has in it (Saturn Outlook)
I guess the bottomline is that I like leasing because it keeps me in a car that is covered by a warranty and I believe that I’m going to end up with a car payment almost always anyways because the idea of keeping a car long after you’ve paid it off is not reality for me – for whatever reason.
Save lots of money because having the cash on hand just gives you a lot more options and flexibility and try to buy a used car with as much cash as possible.