Lease Versus Buy

A common question asked by many consumers is whether to lease or buy, and what the difference really is between each option. The answer really depends on the details of each buyer’s situation – and this is where an experienced, knowledgeable auto broker such as Auto Consultants can really be of service.

A lease is essentially the finance of the use of a vehicle for a certain period of time, while a loan essentially finances the purchasing of the vehicle. A lease is typically payment for use of the vehicle for two or three years, and is also subject to limitations on how far you can drive it during that time. At the end of the lease, you can pay more money to buy the car, or sell it or trade it in, or return the car and look for your next vehicle. The advantage to this approach is that your monthly payments are much lower, and you’re always driving a relatively new car with less risk of breakdowns. On the other hand, if you purchase the vehicle, it’s still yours at the end of two or three years, and over a longer period of time the overall cost is less...but the longer you hold onto it, the more risk there is of breakdowns. And your monthly payments and down payment requirements will be higher.

So it’s important to understand your own situation: Is it more important to be driving a new vehicle every two or three years, with fewer repair risks and lower monthly payments? Or is it more important to own the vehicle, and pay more in the beginning but less overall during the course of your driving life?

Essentially a lease is like taking a slice out of the life of a car and paying only for that slice. So when you buy, your purchase price will cover the entire cost of the vehicle (including your down payment), sales taxes, and interest on the loan you take out to finance the purchase. You can drive the car all you want, because you’ve purchased it outright. When you lease, you pay only only for the portion of the vehicle’s life that you use up. Depending on the terms you select, you’ll have a fixed period of time and mileage that you’ve paid for. Your payments will typically be less because 1) you are often not obligated to make a down payment (although a security deposit may be required), 2) your monthly payments cover only a portion of the overall cost of the car, 3) the sales tax you pay is based on these lower monthly payments, and 4) your money factor (similar to the interest on a loan) will also be based on this lower overall cost. However, you may have to pay extra fees.

The basic numbers

Let’s say you lease a car that costs $20,000. After 24 months, the car is worth $13,000. You lease payments would pay for the $7000 difference (this is called depreciation), plus finance charges, plus fees.

If you were to buy the same vehicle, you would pay the entire $20,000, plus finance charges, plus fees.

Since $7000 is much less than $20,000, it’s not hard to see why the monthly payments are lower in leasing.

But...

Let’s talk about mileage

The mileage factor in leases is important to understand. A 2-year, 12,000 mile lease (which is very typical) means you can drive 24,000 miles over the life of the lease. If you go over that amount, you would typically have to pay something like $0.15/mi, which can translate into a nasty surprise; but on the other hand, you can save money by choosing a lower-mileage lease (e.g., a 10,000 mile lease which means you can drive 20,000 miles over two years), or pay a reduced overage rate (typically $0.08/mi) if you know upfront you’ll drive more. The higher the mileage you choose, the less residual value there is on the vehicle, which means that if you wanted to buy the car at the end of the lease, it would cost you less. So, if for example, you paid for 15,000 miles a year but only drove 10,000, at least if you purchased the vehicle you might see some of that money come back.

There is no mileage factor in buying, since in buying you’ve essentially paid for blanket coverage for “all-the-miles-you-can-drive.”

My lease is up – now what?

At the end of a lease you have a few options. You can typically give it back, you can buy it, you can trade it or sell it to a dealer, and you can have a third party buy it. If you buy it or sell it you do not have to pay any mileage overage charges (see the discussion above for more information about mileage). If you give the car back, they charge you a disposition fee, which is usually around $200-$400. Also with a lease you can return the car with normal wear and tear, but if there is any damage beyond that, you will either have to get it fixed first or pay the lease company for the repairs.

The depreciation game

Regardless of whether you lease or buy, the value of your vehicle will be “used up” over time. This is known as depreciation, and explains why the resale value of a car is less than the purchase price – simply put, you’ve used up some of the car, so you can’t expect to sell it to someone else for full price. However, this has some important ramifications when looking at your overall strategy in where to put your money.

Although it is true that, in leasing, you will not own anything once the lease runs its course, keep in mind that what it is that you don’t own will be the same thing that a purchaser wouldn’t own – namely the depreciated portion of the value of the car. The portion of the principal that a purchaser with a loan pays that is not consumed by depreciation is all that the purchaser really has to show for the investment. This is money that might, in fact, be better off invested in assets that could appreciate, such as stocks, bonds, real estate, etc. Of course, if a purchaser buys a car outright without financing and intends to keep it beyond its depreciable life, then it’s possible to reduce the lifelong operating cost of the vehicle below what’s possible with leasing.

Run the numbers

The issues we’ve discussed are just some of the variables to consider in making an educated decision. There are others – including the issue of gap insurance, your current versus future financial situation, and so on. In short, many advisers argue from a purely financial perspective, that leasing is cheaper in the short term, leasing and buying are equal in the medium term, and buying is cheaper in the long term. However, because it’s easy to look at only one piece of the puzzle and not factor all the considerations in when deciding whether to lease or buy, working with experienced advisers like Auto Consultants will help you avoid the pitfalls. Best of all, this expert advice comes at no cost to you!