Last updated on February 1st, 2021 at 08:34 am
When buying a new car, the upfront cost compared to leasing a car is a big investment. However, it makes more sense to buy a car than to lease because it will be cheaper in the long run. Leasing a car usually means you pay a fee to the dealership or whoever owns the car to have the benefit of driving it, but you do not own it. It is kind of like a long-term rental. Leases are usually 3 years, but some people prefer a 2-year lease because they do not want to be tied into a longer lease. Most leases are for new cars and can be very enticing for someone. Especially one who does not have a lot of money, but wants to drive a nice new car. Leasing attracts some people who think they are going to save money. They think, why not, I can drive a fancy new car for a lot less money than buying it? This may be true if comparing the monthly payments, but not in the long run. It can cost more for leasing a car than buying.
Leasing Fees Add Up Quickly
Some of the most common costs of leasing a car are (but not limited to):
- Signing fee
- Misc fees (title, license, doc, etc.)
- Down payment
- A monthly payment (sales tax is rolled-in)
- Interest (this will vary)
- Miles allotted for three years or price per mile
Normally, at the end of the lease, there could be more charges:
- A disposition fee
- Additional fees for extra miles (these can add up very quickly)
- Any damage incurred
- An extra charge the dealership says exceeds what they call “normal wear and tear”
There are many limitations on leasing a car. If you exceed your total mileage allotment for the length of the lease, they will charge you an extra fee. Usually, this is a set amount per mile over your allotment. If you are not diligent in watching and adjusting your driving, this can add up to several hundred dollars or more. Dealerships consider “normal wear and tear” differently than you do. Even if it is a little ding or scratch from a parking lot, or someone spilled a drink in the car that left a little residue, they could charge a lot extra for this. Your final bill after turning in your car, or even if you buy it at the end of your lease, will be considerably higher than if you had just bought the car. Also, sometimes life happens and you either don’t need the car anymore or can’t afford it. Unfortunately, getting out of a lease is difficult and again can be very costly to you. When you buy a car, you own it and your payments eventually will stop. If the need arises, you can sell it and keep the money. Another cost is insurance. Many times people have to take out higher insurance for a leased car. Also, people do not realize that their insurance is not good enough if you are in an accident. The insurance will pay out the fair market value, but this amount could be less than what you owe on the leased car. If this happens, then you will pay the dealer for a car that you cannot even drive. This could be avoided though if you take out gap insurance for an additional expense.
Buy or Lease Scenario
Say you want a compact car, but think leasing will save you money because the monthly payments are lower than taking out a loan to buy it. Let’s look at a hypothetical comparison of buying vs. leasing. A lot of factors will be the same for both buying or leasing. The total price is $20,000, you negotiate it down to $18,000, put $2000 down, the tax rate is 8% and the interest rate is 4.25%. (The interest rate will change depending upon your credit score. The higher your credit, the lower the interest rate. Which means if you have poor credit, the interest rate will be much higher and cost you more). The terms of the loan or lease are 36 months. The value or residual value of the car at the end of 3 years is $12,200. The monthly payment for buying the car is $475, for $6,900, if selling the car after 3 years ($2000 down + ($475×36) -12,200) and $19,100 if keeping the car ($2000 down + ($475×36). With the lease option the monthly payment would be $167.94, for a total of $8045.84 ($2000 down + ($167.94×36) and $20,245.84 to buy it at the end of the lease ($2000 down + ($167.94×36) + $12,200). As you can see the lease option is actually more money. This is especially true if you are going to keep the car for many years. The longer you keep the car, the cheaper it is since you would only have maintenance costs and no monthly payments. The above example is using the interest rate of 4.25%. This will probably be higher for you since many people have lower credit scores. There are different sites that can help calculate an estimate of leased monthly payments.
Dealerships Profit on Leased Cars
Think about it logically. If leasing a car was a way for you to save money and the dealership did not gain from it, they would not do it. The majority of cars that leave the lots are leases, not sales. This is because the dealership makes a lot of money on the leased cars because they pass on the depreciation to you. You are paying the largest part of the depreciation of the car. Cars tend to depreciate the most in the first two years. Therefore, a 2 year lease is even more costly because you are paying at the highest peak of depreciation for the car. Car dealerships push leases and say you can have lower payments and a stylish new car to drive today. They are not looking out for your best interest, it is a business. The finance charge is called interest, if you are borrowing money. There is an Annual Percentage Rate (APR) and the federal Truth in Lending Act (TILA) statement. The TILA states the actual cost of interest you will be paying. When you lease a car, it is not technically under the law to be disclosed so most of the time it is not disclosed what you are paying for with your money. You will see the amount being financed, plus any add-ons and taxes. It rarely shows the interest. Most likely because it will be very high. You could calculate it by taking the MSRP of the car at the beginning of the lease, the residual value, and take out your monthly payments. Then you can calculate the interest rate you are paying. This could be very high; it might be 15% and this technically is not disclosed. Therefore, the dealership loves it, because you are paying the depreciation, a large amount in interest, and most likely a lot more fees at the end. For instance, the mileage, damage they assess, and any other incidentals. It is a win-win situation for the dealership.
Leasing a car isn’t a terrible idea, especially for people who have a lot of money and realize that it is not an investment. Most people don’t have extra money to spend on a car that is not theirs. As you can see, leasing costs more than buying and it is not a sensible financial decision if you are trying to build your financial wealth. When your lease ends, you go to turn in your car and pay all the added charges. You turn it in with low miles and many years of good reliability left. The dealer sells it used for a lot of money and ends up making a hefty profit on a car you paid most of the depreciation. The dealership likes that you have to come in person to return the car. They can work their magic on you to sign another lease. It is much easier for them to do in person. This could go on for years and even decades and you have spent an incredible amount of money never owning a car. If money is not an issue, then leasing might be a good option. It is very important to remember, you do not have any equity in a leased car, just a lot of money out. A lease is one of the most expensive forms of using a car and not owning it. Whether you buy or lease, the best thing to do is research, calculate, compare, and negotiate. Look at the total cost and not just monthly payments to help you make an informed decision.