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An age-old debate came up with a friend recently. He is in the market for a new car, and upon my asking whether he would be leasing or purchasing, he responded with a terse “Buying, of course. Why would I want to pump all that money into a car and not even own it?”. His position is one that is not at all uncommon, especially within the personal finance blogosphere. However, at the risk of playing devil’s advocate, if you properly negotiate your terms leasing may actually prove to be a better financial decision.
There is little doubt that a new car is almost always a bad choice from a purely financial perspective. The moment that shiny new car drives off the lot, it depreciates by 20%+. The hemorrhaging doesn’t end there- most vehicles continue to depreciate by 15% or so every year for the first 5-6 years of ownership. If you’re looking to avoid purchasing an asset that depreciates rapidly, don’t even bother to look at a car that’s less than 5-6 years old.
Despite this, many people choose to buy new, and there are a number of reasons for doing so. The debate over the wisdom of buying a new car every few years is best left for another day, and it is a moot point in any event- once you’ve decided that this is what you want, the real question becomes what is the most effective and efficient way to accomplish this.
The Basics of Leasing
First, a few fundamentals about leasing- when you lease a vehicle, you only pay for the vehicle’s depreciation over the term of your lease. This is determined by taking the estimated value at the end of the lease term (this is called the residual) and subtracting it from the total purchase price. Your payments are then based on this amount, plus applicable money factor (essentially the interest rate / lease rate you will pay) and sales tax. At the end of the term, you have the option of either buying the vehicle for the pre-determined residual, or returning to the dealer.
If we assume identical negotiated purchase prices and identical rates of interest, the total of your lease payments PLUS the residual value of your vehicle will always work out to be a little bit more than the total you would have paid to finance over the same term. The amount of this difference will vary from a few hundred to over a thousand dollars, depending on the interest rate, the term, and the value, but it is an inescapable mathematical fact. The reason is that in both leasing and financing, you pay interest on the full value of the vehicle, and in a purchase situation, that amount (and therefore the interest payable) is being reduced at a faster rate.
However, there are some situations where leasing can actually work out to be cheaper- namely, when the interest rate offered is lower on the lease, or where a longer term is chosen on the purchase. And even though you may pay more in interest on your lease, you will have substantially lower monthly payments, usually in the range of 30% -50% lower. If put to good use, the money you save can recoup the bit extra you paid to lease. If you invest that extra money in a high interest savings account earning more than your lease rate, you’ll actually come out on top. If you use that extra money to pay down other debt with a higher interest rate, you’ll do even better. Of course, many people fail to do this and then complain at the end of their term that they’ve got nothing to show for 48 months of payments, which is part of the reason why leasing gets a bit of a bad rap.
The Advantages of Leasing
With these points in mind, leasing can offer several advantages over purchasing. First, you tie up fewer limited resources in a depreciating asset. As much as possible, I like to invest my limited funds in assets that will make me money, such as real estate, my investment portfolio, and the counterfeit banknote printing setup in my basement (just kidding- I’m here all week, folks! Try the veal!). From an investment perspective, unless you’re picking up an extremely rare and coveted auto (a Honda Civic doesn’t fall in this category), there are few assets that will depreciate faster or with greater vigor. Whether you lease or buy new, you still pay for the depreciation (that’s inevitable), but why tie up more funds than needed in a losing proposition? As mentioned above, the money you save in monthly payments can be put to any number of other purposes.
Second, leasing may offer better rates and incentives. In my most recent car shopping adventure I found notably better rates and incentives for leasing over purchasing. For example, I was able to find notably better rates on leasing than on purchase financing (0.9% lease vs. 2.9%) on a Subaru Impreza through GMAC. This scenario was repeated at a number of different dealers. Such a variance in rates is not uncommon, as many manufacturers subsidize their leases. However, the availability of aggressive lease incentives is waning, especially on larger vehicles and from Detroit, although I still see some pretty impressive lease numbers on some other makes.
Finally, leasing gives you greater flexibility and certainty. Many people want to drive a relatively new car and, as a result, even people who opt to finance the purchase of their vehicles will often sell or trade-in after a few years, in many cases before fully paying off the car. In doing so, the value of your vehicle is at the mercy of the market at that particular moment. Any number of factors can affect the price you will get for your car at the time you wish to sell, including market saturation of a particular vehicle type, new features and technologies on the market, new design trends, and even factors such as fuel prices. I certainly wouldn’t want to be trying to sell a full-size SUV in today’s market- you’re sure to take a bath on it. When you lease, you agree on signing what the value of the vehicle will be in a set number of months- when that time comes, you have the option of purchasing the vehicle at that price or turning it back to the dealer. The risk of market fluctuation lies with the leasing company, not with you. If your car is worth a fair bit more than the residual at term-end, sell it privately and pocket the difference. If not, turn the keys over and start looking for your next car. And if you really like the car, take the money you saved and buy it out- you should have just about the right amount.
When Leasing Makes Sense
So when does it make sense to lease? At the risk of sounding trite, it makes sense when it saves you money. If you don’t want to keep the car more than a few years, you can accurately predict your annual mileage and you take reasonably good care of your vehicles, you may be a good candidate for leasing. Whether leasing will actually save you money or constitute a wise financial decision will depend largely on the purchase price and lease rate you negotiate, as well as what you do with the difference in monthly payments. Make sure you fully understand the price you’re paying, any fees involved, the money factor, and the end-of-lease terms. When you have a full picture of your lease, compare it with your best financing option to see what makes more sense for you.
Tips for Negotiating a Lease
- Do your research- know the MSRP and dealer invoice prices. CarCostCanada provides accurate wholsale invoice price reports for a small fee- they are well worth the cost, and could save you thousands, regardless of whether you lease or purchase.
- Don’t start off negotiating a lease- start by negotiating a price- and this means out the door price, not monthly payments. Options for financing the price can be discussed after. Don’t be afraid to switch back and forth between options to find the best incentives.
- Get a full breakdown of the purchase price and any fees, taxes, or levies included. Don’t be afraid to ask questions and try to get a better deal.
- Use a calculator such as the Lease or Buy Calculator offered by Industry Canada to compare financing options. You can also use spreadsheet calculators such as this one to compare lease options and ensure your numbers are adding up like they should.
- Read and understand your lease. Know your mileage and wear limits, any overage charges, termination charges, and buyout fees. Everything is open to negotiation!
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I must say this is a great article i enjoyed reading it keep the good work
Hi. I am a long time reader. I wanted to say that I like your blog and the layout.
Peter Quinn
MGL, you’re missing one major point- you’re never going to be able to negotiate as good a price on a lease as you will on a cash purchase. Any nominal benefit you might see will be wiped out compared with what you could have saved.
@Lard Black- you’re right that you can usually negotiate a better price with cash, but I think it’s a stretch to say that you can never match that price on a lease. If you negotiate right, you can come pretty close.
When you get a better cash price, you need to factor this in to your calculations to see what makes the most sense overall, including the cost of using that cash (whether in the form of interest paid or earnings lost).
Again, I’m not saying that leasing is always the best option. But it is an option that deserves consideration.
Oh, and thanks to both Peter and Susan for the kind words. Any feedback is always appreciated!
MGL: Good analysis. However, in the US auto leasing is falling out of favor except for high end imports. (The number one leased brand is BMW.) Chrysler has stopped leasing altogether and other domestic companies have stopped most leasing incentives. I would also suggest that many people who deduct lease payments as business expenses are cheating like crazy.