If you are looking to get into a new car, one of the first decisions you will have to make is whether you want to lease the vehicle or buy it. There is a third option of paying for a brand new car in cash, but not many people do that and it actually isn’t a very good idea because you risk losing a lot of money if the car is totaled. But that’s a post for another day; for the rest of this post, when I refer to “buying” a car, I mean taking out a loan to purchase said vehicle.
When you buy a car, you take out a loan and make a monthly payment with interest. When you are done making payments, you are the proud owner of that car! Well, the car will be worth about a third of what you paid for it, so you might be the ashamed owner of that car. But at least it’s yours, right?
With a lease, you don’t actually buy the car; you are just paying for the privilege of driving it for a certain amount of time. You make monthly payments to the dealer, and you give the car back when the lease is up. At you end of your lease, you are the proud owner of, well, nothing. It sounds like a raw deal to pay thousands of dollars for a car without owning it eventually, so most people assume buying is better than leasing. And most people would usually be wrong. (not always, but usually)
When I leased my Camry last year, a lot of people told me I was dumb for leasing instead of buying. Then I smacked them down with the logic I’m about to show you, and they changed their tune. Let’s take a look at the 2010 Toyota Camry I leased about a year ago and review the two real-life options I was given.
Buying a 2010 Toyota Camry
Sale Price: $21,000
Financing: 5 years @ 0.0% APR
Payments: 60 payments of $350.00
If you’ve ever taken out a loan for something, this should make a lot of sense to you. I bought my Camry right after Toyota was in the news for all sorts of safety issues, so they were offering 0% financing on Camry’s to help drive business after all the bad press they were having. That APR is only available for people with good credit, and I did have good enough credit to qualify. As you can see, I would have paid $350 a month for five years, and then owned the car in 2015.
Leasing a 2010 Toyota Camry
Sale Price: $21,000
Lease Terms: 3 years @ 0.0% APR
Payments: 36 payments of $194.44
Residual Value: $14,000
When you lease a car, you essentially pay the difference between the purchase price and the residual price. The residual price is what the dealer estimates the car will be worth at the end of the lease. In my case it was $14,000. That means I will have to pay $7,000 over 36 months. After the 36 months are over, I have the option to either give the car back to the dealer or keep the car and give the dealer $14,000. It’s up to me which option I pick, so I get to choose the option that is best for me at the time. You’ll see in a minute why the residual value is a car buyer’s best friend.
Buy vs. Lease After Three Years
Let’s fast-forward to the end of three years. If I had bought the car, I would have paid $12,600 in car payments. If I had leased it, I would have paid $7,000 in lease payments. That means by taking the lease, I would have $5,600 more in my pocket thanks to the lower payments. The lease is already looking good. Now let’s look at a few scenarios of how much the car is worth after three years, and whether buying or leasing makes more sense.
Pretend the car can be sold for $16,000 now. If I had bought the car, I would have paid $12,600 already, meaning I would still owe $8,400 on the loan. I could sell the car at $16,000, pay off my loan, and be left with $7,600. If I had leased the car, I could sell it at $16,000 and give the dealer $14,000 instead of turning in the car, which is a profit of $2,000. Then when you add the $5,600 I saved from having lower lease payments, I end up with $7,600. It doesn’t matter whether I buy or lease the car, I still end up with $7,600.
In fact, if the car is worth as much or more than the residual value of the lease, there is no difference between buying or leasing. You’ll end up with the same amount of money.
Now let’s pretend the car is only worth $10,000. Maybe Toyota had another safety issue and resale value plummets. If you had bought the car, you would still owe $8,400 on the loan. You can sell the car, pay off the loan, and end up with $1,600. However, if you leased the car, all you have to do is turn it in and let the dealer take the $4,000 hit. You’ll still have the $5,600 you saved from the lower lease payments, and you’ll be $4,000 ahead of someone who had bought the car.
To summarize, if the value of the car is equal or higher to the residual value of a lease, then there is no difference between leasing or buying. However, if the value of the car is lower than the residual value, the customer loses money on a purchase, but the dealer loses money on a lease.
The Best Reason to Lease a Car
When you lease a car, the dealer is assuming all the risk for the car losing value. That’s why leasing so freaking awesome. A lease basically means the car dealership signs a contract promising they will buy your car back from you in three years at a certain price (the residual value). If the car is worth more than that price, sell it to someone else, pay the dealer what you owe him, and keep the change. If the car is worth less than that price then you just turn it in, make the dealer take the loss, and laugh all the way home. Just make sure you have a friend to drive you home, because you won’t have a car anymore.
Why Leasing is Usually Better
- Lower monthly payments puts more money in your pocket because of lower payments
- The ability to sell the car if it is worth more than the residual value
- The ability to return the car if it is worth less than the residual value (my favorite)
OK, OK, Leasing Isn’t ALWAYS Better
Now that I’ve made my pitch and it is very clear that leasing is usually better, there are some instances where a lease doesn’t make sense.
- APR is above 0.0% – Smaller payments means a higher balance which means more interest, so if you are paying interest on your loan/lease, it will be slightly more expensive to lease for three years. The higher the APR, the more expensive it will be to lease as opposed to buying. I’d probably take a 2.9% lease over a 2.9% loan, but I’d probably go with the loan at 4.9%. I would take the 2.9% loan because I still want to put the risk of the car losing value on the dealer.
- You Drive A Lot – Most leases only allow you to drive 12,000 miles a year, and if you go over they charge you something like 10 cents a mile over your limit. If you can’t keep your miles down, leasing isn’t for you.
- You Want to Keep The Car After 3 Years (maybe) – If you want to keep the car after three years, you will probably have to take out a loan to purchase it. Now you’ll be looking at a used car loan at much higher than 0.0% APR. However, if the car’s actual value is much lower than the residual value, you can turn it in to the dealer and then immediately buy it back from them at the lower price. This will save you lots of money and may end up being cheaper than purchasing in the first place.
Lease Your Car and Fleece the Dealer
If you made it this far, then you know why I am proudly leasing my brand new car. You might be thinking that buying a used car is cheaper, but a used car doesn’t come with a full bumper to bumper warranty (don’t get me started on extended warranties for used cars; I hate them). I love the convenience of a zero-hassle car and low monthly payments, which is why I’m leasing. If you’re looking to get a new car, you should probably consider a lease for yourself.
Kevin McKee is an entrepreneur, IT guru, and personal finance leader. In addition to his writing, Kevin is the head of IT at Buildingstars, Co-Founder of Padmission, and organizer of Laravel STL. He is also the creator of www.contributetoopensource.com. When he’s not working, Kevin enjoys podcasting about movies and spending time with his wife and four children.
As long as you’re not leasing a Mercedes or something silly like that and you can afford the payments, I don’t see the big deal that people make about leasing vs. buying. Used cars are a huge gamble, so why not pay a bit of a premium and get something new? And at 0% financing, that’s even better…
Yeah, I’m a big fan of the 0% financing. You just have to find the right dealer at the right time to get a good deal, but it’s worth it for me.
The one thing you didn’t mention is if there are down payments for the lease; I tend to see a lot of commercials with $1,000-3,000 down for a lease, did you not pay one at all? Thanks for this post, I was actually wondering what your logic was on this!
I didn’t have a down payment. I paid some money up front for my first month’s payment plus tax, title and license, but it wasn’t a “Down Payment”. It’s still an option at some dealers today. For example: http://westborotoyota.com/Zero-Down-Toyota-Lease/
I think leasing is excellent for people who are most interested in 1) having a reliable car and 2) having certain cash flow/reducing monthly out-go.
I suggested to my girlfriend that she consider leasing while still in school. A Nissan Altima could be leased for 3 years at $119 for just a small up-front payment. Ultimately, she just bought a used car, but for $119 it was mighty tempting.
Great article, Kevin. Awesome comparison between the two options.
An Altima for $119? If I can find that deal in 2 years, that will be my next car!
I’m sure it will be around. The Altima is perennially ranked as one of the best mid-size cars for resale value. They’re a pretty decent value, and money aside they sure are beautiful!
Just for future reference: I think it was a 39 month lease term with $2,XXX down at signing. So you’re looking at +/- $169 per month over the life of the lease for a ballin’ car. I’m not sure how crazy the options were, but it’s a deal I’m definitely putting on my future radar.
Considering that I drive a great deal and always keep cars for far longer than 3 years I have never leased.
I have a friend who always leases his family cars. He constantly has a monthly expense that I don’t have to deal with.
He claimed that he did it because he “didn’t know anyone who had paid off their car loan and still had that car” and “a monthly payment is a monthly payment”
He was shocked when I told him that both my car and my wife’s car were paid off.
You’re the man Weston! You obviously knew what you wanted to do and made the right decision for your situation. That’s the great thing about personal finance; we call do it differently and both be right. It’s good to hear you’ve put yourself in such a great financial position with you’re vehicles!
This is exactly what we do. we run our cars into the ground. we don’t believe in having a perpetual monthly payment just to have a newer car. when i bought my first new car 2 years ago, the dealer kept trying to push me into a lease (making me believe it’s much better for them than buying). He didn’t believe me when i told him I had had my last car paid off for the last 4 years and that I look forward to getting to that day when I make my last payment.
But i guess that’s the American way: something shiny and new is always just around the corner. Why fix it when you can replace it? We just believe in being more sustainable.
Good post Kevin. Now I see why you lease a car. I have never lease a car and always hear bad things about it so I didn’t look into it that much. Maybe next time we’ll lease one! Our car is paid off though and hopefully it’ll last at least 10 years. 😉
I think this is a key point. If you pay off your car and it lasts 10 years – for the remaining years where you do not have a monthly payment you can save serious cash. If you can find a reliable used car where the starting price is lower than the price of the leased car then you would always save money over the long term. Here you are comparing the same car – but if you chose to purchase something cheaper than the types of cars available for lease, the numbers may come out different. In your very first paragraph you skip paying for a used car in cash – where it’s paid off, there is no APR, and you don’t have any payments and can save for 10 years
I’m very much with Morgan on this. Even though they get heavy use our cars generally last us around 9 years before the repair costs get to the point where we feel we should buy another car. On an average that’s 5 or 6 years without a monthly payment.
Great article! So you just don’t make videos! 🙂 I leased a few cars and I thought I was making the right choice at the time. I didn’t want to deal with maintenance issues. I wanted to get into new cars around three years. I wanted the lower monthly payments. Now I am on the opposite side of the spectrum. I bought a used car. I did have to deal with a brake job, but wasn’t as bad as I thought, just needed to educate myself. I’m saving a ton on no monthly payments and saving on auto insurance because a lease requires the maximum coverage.
In your scenario, leasing sounds like a great option (especially since you can invest the difference in cash flow). However, to me this is very similar to your post about good debt.
I would argue that leasing (like good debt) is a terrible idea for most people. You have done the math, you found an amazing deals. Most people are not going to do the math. Here are some reasons I think leasing is a terrible idea for most people.
1. You received very favorable terms (thanks to Toyota’s quality problems). Most people don’t show around and wait for these deals.
2. There are a number of ‘gotchas’ in the contracts. I know you pay attention to these, but there are plenty of people that will pay 5 cents a mile without noticing.
3. People don’t save/invest the difference. They use the cheaper lease payments to buy a fancier car
4. Who pays attention to the resale value at the end of the lease? Folks will usually simply lease another car without looking at resale values negating the main benefit of your logic.
Don’t get me wrong, I think what you are doing makes financial sense. But you have to remember most people are stupid (or just don’t care) and therefore will be better off buying.
I bought my Corolla with a 4.49% loan (this was when EVERYONE was buying fuel efficient cars). I was keen to pay it off quicker than the 5 year loan I’d taken out. So I ended up paying off the whole loan in two years. So now I own my car outright, and I plan on keeping it for as long as possible.
Oops, put my email and blog url in the wrong spots.
Nice points, too bad I drive too many miles to make this work. I’ve heard that buying anothers car off of a lease can be a good way to save money.
Yeah, this is definitely an “it depends” situation. My dad is a self proclaimed Car Guy. He leases cars all the time because he usually only keeps them for a year or two (seriously – it wasn’t until I was in middle school that I realized people keep cars for longer than two years) so for him leasing makes sense. For me, not so much. First of all, I drive A LOT. Second of all, I don’t have a real interest in constantly getting a new car, so for me buying a car and holding on to it is the best bet.
Another point about leasing: there’s the financial school of thought that you should only pour serious money into assets that appreciate (like a house) as opposed to those that depreciate (like a car). By this reasoning, leasing a car makes sense. Why pour tons of money into something that is GUARANTEED to nosedive in value?
Okay, I’ll bite: why does buying a new car with cash risk losing a bunch of money if you total it? Presumably if you’re buying a new car, you’re also insuring it.
Say you buy a brand new car for $20,000. The moment you drive it off the lot, it might be worth $18,000 because it is used. If you total your car, the insurance will pay you the current value of the car, which is $18,000, and you’re out 2 Gs. This is why people get GAP insurance when they take out a loan for a car. I’m not aware of any kind of GAP insurance that is available to people who own their cars.
I agree with Hoff, for most people leasing doesn’t work because they don’t spend time paying attention to the details. I usually pay off my car loans within 3 years, unless the interest I am earning is greater than what I am paying. So I usually have 5-7+ years of no car payment. Leasing can be good if you really only want the car for a couple years. A friend of mine has been wanting to buy a luxury vehicle most of his life but he decided he really only wants it for like 3 years, better to lease.
Finally, a personal finance writer who doesn’t blindly parrot the conventional advice that leasing is stupid. I chose to lease my car for various reasons, and I think it was the right thing for me to do. I like driving new cars that are under warranty because I don’t want to deal with repairs, and I don’t have another way to get to work if my car breaks down unexpectedly. I am well under my mileage allowance, so I’m not worried about paying for excess mileage. I actually could pay cash for a new car, but why would I want to tie up tens of thousands of dollars in a car when I can just pay for the depreciation?
My problem now is that my lease is up this month and the car is worth more than the residual value. Seems like a nice “problem” to have, because in theory, I can buy out the lease and sell it for more, but one of the other reasons I like leasing is avoiding the hassle of selling a car. I could use it as a trade-in to buy a new car, but then I would still have money tied up in a car. I had always planned on turning it in and leasing a new car, but now I’m not sure if I should pass up the opportunity to make a few thousand bucks.
You made a comment about loving zero percent financing. Just recommending that you run the numbers. Depending on what the dealer is trying to promote, zero percent financing may be a worse deal than getting a rebate and loan on the after rebate amount (e.g. for your $21K example a rebate of >$2500 with an interest rate of 5% starts being better). So run the numbers on what loan percent you can get and what rebates they may be offering to see which is really better for you.
You left out one other advantage of leasing. You only pay the sales tax for the portion of the car that you use. In your Camry example above, buying the car for $21,000 would generate sales tax of $1627 (based on the 7.75% sales tax rate where I live). However, if you had leased it, at the end of 36 months you would have only payed $525 in sales tax based on your $7K of lease payments saving you over $1,100 in sales tax if you decided to turn your car in (in the lease option) vs selling it at the same price (in the buy/sell option).
I have always been taught that leases are horrible by my father who is accountant. After reading this I have changed my thoughts. I am a business owner and it would make more sense to keep more cash flow in my pocket. A lease can definitely be a better deal if you do your homework.