Should I Lease My Next Car?
That’s a big question – with a short answer: it depends. Everyone’s situation is different, so there is no substitute for a good sit-down with a leasing expert to help you see the whole picture clearly (just come to an upcoming workshop).
Let’s take two examples: Jack and Jill. Let’s also pretend that taxes and fees don’t exist (ah, utopia… *sigh*).
Jack likes to keep his cars for at least ten years. He keeps his vehicle in top shape, attending to any serviceable issue as soon as it arises – and takes pride in washing it by hand every Sunday morning. Since Jack is a stock market investor, he works from home and does very little driving. His car, for which he paid $30,000 cash, has only 75,000 miles on it – after a decade of ownership.
Jill is a young, up and coming independent real-estate agent. She practically lives in her car and it’s important to her that her clients see her as professional, savvy, and modern. Her extremely busy schedule keeps her on the go, racking up about 20,000 miles on the odometer annually. Her car, which she also bought for $30,000 has accrued 60,000 miles (and a few dings and scratches here and there) in three short years.
Let’s suppose that Jack and Jill are both ready for a new car. Both are financially equipped to handle a car payment or pay cash on the spot. What should they do? The conventional wisdom is that since Jack keeps his cars for such a long time he shouldn’t lease – especially if he can afford to buy with cash. Most would say that Jill drives too many miles to lease and that she should buy if she can afford it. Let’s take a closer look at Jack and Jill’s current cars.
Jack’s car is immaculate and is considered “low miles” (12,000 miles a year is about average; just divide by 365 and see if that’s about your daily commute). When he goes to trade it in or sell it privately he can expect top dollar – but the car is ten years old, so it’s depreciated quite a bit. Let’s say for argument’s sake that it’s worth $8,000. This means that all-in-all, Jack’s car truly cost him $22,000 excluding maintenance, repairs, fuel, insurance, et cetera.
Jill’s car is in OK shape, but it needs tires and a few cosmetic touch-ups. Her car is way over the average and as a result it isn’t nearly as desirable at the time of resale. Her warranty has long since expired and the “Check Engine” warning is lit up on the dash. She just hasn’t had the time to get that looked at! Because of the condition of the car and the heavy mileage, the car appraises for a mere $10,000 – making her true cost of ownership $20,000 plus expenses.
As a result of their vastly different lifestyles Jack ended up spending $2,200 a year on his car, Jill spent over $6,600. Both Jack and Jill are looking at a similar new model, price tagged at $30,000.
Scenario 1: Jack and Jill stroke a check for their new cars, respectively – dropping their checking account balances by $30k.
Scenario 2: Jack and Jill finance their cars, putting down $10,000 and carrying the balance for 60 months at 5% interest.
Scenario 3: Jack and Jill lease their cars, putting down $2,500 each for 36 months.
Scenario 4: Jack and Jill lease their cars paying a one-time lump sum for the entire lease balance, though the term is still 36 months.
In scenario 1, it’s business as usual; Let’s see what happens with Jack and Jill in scenario 2:
- Jack: Since he put down $10,000 his $20,000 loan ends up costing him about $375 a month x 60 months, for a grand total of $22,500 (plus his down payment = $32,500). The advantage is that Jack was able to keep $20,000 more dollars in the bank at the time of purchase – and that’s important to him in case he needs to buy some hot stocks in a hurry. He feels this is worth the drawback of paying $2,500 extra dollars to the bank in interest. Ten years later, he sells the car and recovers his $8,000. Total cost of owning the car? $24,500.
- Jill: Jill also enjoys the security of keeping her money in the bank. But since she rings up the miles on her cars and needs a new one every three years to keep current, she runs in to a bit of a problem. Three years into her loan she’s paid $13,500 back to the bank, meaning she still owes $9,000. But, since she’s depreciated the value of her car so much by her driving habits, it’s only worth $10,000 – enough to cover what she put down. So when it’s time to get a new one, she finds herself writing two checks – one for the next car, and one to catch up on this one.
In Jill’s case, she still ends up paying the full amount ($32,500) for the car and getting back her initial investment. She just ends up doing it in a “buy now, pay later” fashion. Again, since the net result is the same, it’s no harm no foul. But what if something happens to Jill’s bank account while she is making payments? What if she just sent her kid off to college, remodeled her house, or invested her savings into a new one? If she goes to turn in her car after three years, that $9,000 (plus the cost of the next car) might be a tough pill to swallow. What would she do? To make that outstanding $9,000 go away, she could keep the car for the last two years of payments. But since the car is way out of warranty (and on its way to 100,000 miles) the service and repair bills are starting to pile up on top of her monthly payments and frankly, the car is starting to look a little shabby – which is having an effect on her professional image.
In scenario 3, let’s suppose that the manufacturer of the new $30,000 car is running a lease special limited to 12,000 miles per year, where the monthly payment is $375 for 36 months with only $2,500 down. [Other posts on this site may go into more detail on how a lease works, but for now let's just go with it without getting sidetracked]. By nature of this closed-end lease, both Jack and Jill end up paying $375 x 36 = $13,500 in payments, plus their down payment of $2,500 which comes to $16,000. At the end of three years, Jack and Jill have the choice to walk away from the car, owing nothing, or decide to pay for the rest of it.
Is this a good deal for Jack? Maybe not – since paying cash for his cars and keeping them 10 years costs him $2,200 a year. $16,000 over three years is a little over $5,300 per year.
Is this a good deal for Jill? Well, let’s be fair – no manufacturer runs a lease special including the 20,000 miles per year that she needs. But, that doesn’t mean she can’t lease – the manufacturer will let her buy the miles up front (let’s say they’re 15 cents per mile). Since she needs 24,000 extra miles above the 36,000 that are built in to the lease, it will end up costing her $13,500 in payments plus $3,600 in miles, plus her $2,500 down payment. All together, her total spend over three years is $19,600 a little over $6,500 per year. But the question was, is this a better deal? In Jill’s case – she only put $2,500 down at the beginning (instead of dropping $30k right out of the gate) and at the end of her lease, she walked away from her car without having the stress of trading or selling it. The lease ended up costing her the same in the big picture, but the ability to keep her money in the bank and simplify her life are two huge benefits.
In the last scenario, the end result is really the same as in scenario 3 – the payments are just paid up front. While this doesn’t do Jill any favors, it might be a good option for Jack – and here’s why:
What if Jack paid $30,000 cash for his new car and after two years go by, Jack is in an accident and his new car is totaled? If he has his insurance company pay to fix it he is made whole again, but he sure won’t be getting $8,000 for it at the end of the decade – he might get half that. You wouldn’t buy a used car for full price that you know had been in a major accident, would you? If Jack had leased that car (whether he makes payments or pays it all in one lump-sum), he would simply turn it in at the end of the three year lease and walk away – the extra depreciation is the responsibility of the leasing company.
Again, the smart move is to start thinking about this now (attend a workshop) and plan a little for the future – it will go a long, long way.