Should you lease your next car?

Should you lease a car or buy the same car. The ads are everywhere these days and looking at the low monthly rates, you can be lured into thinking that it's a great deal. So, I decided to look at the auto lease in some more detail and give my thoughts on the pro's and con's of leasing a car over buying one new. I decided that the best approach would be to answer the basic questions below.

What is a lease?  

A lease is basically renting a car for the term of 2-4 years and paying any depreciation that the vehicle incurs during the lease term.  What the car is worth at the end of the lease term is referred to as the residual value and is estimated by the dealer when the lease terms are set.  A lease is a good deal for the lessee when the residual is over estimated by the bank/dealer allowing the calculated monthly fee to be lower and the overall depreciation paid being less than the actual.  You agree to the number of miles that you can drive a year, usually 10-12k, and you also agree to pay for any damage to the car when you turn it back in.  If you go over the milage, you will pay 15-25 cents a mile, so make sure you don’t go over.  By the way, the more miles you build into the lease the more it costs every month.  Just like a car you own, you are responsible for maintenance and often times must take it to the dealer for said maintenance.  Anything that turns into a major repair is usually covered under the warranty unless the lessee was at fault.  

Should you lease a car?

It really depends on your financial ability to have a monthly payment on a car.  As long as you lease you are set up to pay those payments for the term of the lease unless you sell your lease to someone to get out of it.  Lease transfers often cause you to pay the person you transfer it to in order for them to take it over.  What might cause you to want out of the lease?  Did you change driving habbits?  Maybe a job change that caused you to drive an extra 20 miles a day?  Lose a job and desire a lower monthly payment?  Did you get in an accident where the car was totalled?  In this last instance, you should be okay as you should have bought gap insurance.  Gap insurance is insurance that pays the difference between what the insurance company offers you when a car is totalled and how much residual is left on the lease.  It is VERY important to get gap insurance as you will be liable for the difference if you don’t have it and it can be thousands of dollars. (Never buy it from the dealer!)  Can I repeat something?  You are never without a payment!  Not having payments is kind of freeing and gives you a lot of options in life, if you sign up for this you are restricting your options in life in several ways.  First, you can’t drive it wherever you want without going over the mileage.  Secondly, you have the payment every month.  Lastly, when you get to the end of the lease, you have nothing to show for it.  You have to sign up for another lease or start over buying a car.

What should I lease?

Expensive cars tend to offer a better “deal” on leasing than less expensive cars as they retain a higher residual for longer allowing you to pay a lower percentage of the car’s value over the term of the lease. That said, you will still be paying a much higher payment than some of the cheaper lease deals and it is not a licence to get what you would be willing to pay if you were to buy the car out right. The idea is to save money right? Well we'll see if that works out later.  Remember the deals you see in ads are usually for the least expensive model of the vehicle and thus the real payment will be more if you add options or bump up to the next options class.  If you do decide to add options, remember that you don’t get them back at the end of the lease.  If you pay a thousand dollars for a dvd player in the back, you just bought the person that buys the car off lease a dvd player.  You paid the full price and you are just getting to use it 2-4 years.  If you want a dvd play, go buy a portable player and keep it when you change cars.

What other fees/costs should I pay?

So we have gone over gap insurance already, but I want to emphasize that you should get it through your insurance provider, not the dealer.  Also, never pay for cap reduction, it might make the monthly payments smaller, but you are paying down the residual, and where does that go?  In the dealers pocket when they sell the car after the lease term.  Unless you plan on buying the car, which you should NEVER do, don’t do any cap cost reduction.

Why not buy the lease after the term?

If you wanted to buy the car, you should have just bought the car in the first place.  You will get a better deal on the car and you are also not out all of the fees and costs associated with the lease in the first place.  Why do you think the dealers push the lease?  It makes them money!  

What about buying a car, don’t you have a cost of ownership that can be as much as leasing in perpetuity?

Well, let's see by going over an example.  This year’s Jetta TDI lease is $219+ $1899 down.  If you were to buy the same car with cash it costs $26,306(edmunds what people are paying).  The residual after 3 years is around $15,000 based on the going rate of a 2012 jetta tdi.  That said, it cost you $11,300 if you bought it with cash and sold it after three years with around 36k miles on it, and $9,783 in lease payments.  If you keep leasing and get a similar deal the next 3 years.  The residual of your 6 year old Jetta is $10,000 and cost is $16,306 if you were to sell whereas the lease has cost for the 6 years is $19,566.  You can see that the break even in this deal is around 4-5 years and the terms of this lease are pretty good as it includes a $1000 incentive and the dealer is over estimating the residual which could influence future lease deals in the upward direction.  Ownership costs of newer model cars don’t tend to be more than the costs associated during a lease due to normal wear and tear until a car hits 90k (timing belt in this case).  So the costs of owning over lease are really negligible in this first 6 years as we are taking the 72k mileage for the comparison.  Even after a car hits 100k miles you will at most incur an average cost of $1000-$1500 a year in maintenance.  Factor in the mandatory stealership visits for the lease for overpriced service and you are even closer to parity.  Of course this will increase over time, but you can easily get to 10 years before these costs really come into play in a major way.  Last year my 14 year old Jetta only cost me $654 over normal tires/oil changes, etc that you are paying during a lease anyway.  That said, if you own the car for 10 years, you are driving a paid for car for 5 of those years.  No payments!  That is a whole car!  This break even can be reduced even further if you buy a 2 year old car and lose out on the first two years of devaluation.  A car really does lose as much as 11% of its value when you drive it off the lot.  So what makes the most sense to you?  Let me know in the comment below.  

Follow up articles ideas (let me know if you have other ideas):

Is the EV car an exception to this rule?  Should you even buy an EV based on long term valuations?