When Leasing a Car is Good & When It's One of the Worst Things You Can Do
Q: My husband and I don’t know if we should buy or lease a new car. We have a 14 year old SUV that we bought new at the time, and our dealer tells us that it has kept its value really well. However, it now needs about $2200 worth of work, e.g. new tires, brakes and a battery. I’ve just gone back to school, and that $2200 could be a down-payment rather than a repair bill, letting us get a new car before our old one costs us some serious cash. The dealer has some great offers on new cars right now so we’re wondering, is the splurge for some new wheels worth it? ~Marcie
A: Few things send a bigger shiver down your spine than replacing your vehicle. With so many options to consider, car shopping can be an overwhelming experience. Then once you’ve decided on what you want, the most confusing part is how to pay for it – do you lease, finance it through the dealer, or buy it on your own?
Beyond the feeling you get behind the wheel, buying a brand new car is a big decision. In the first year of ownership, the car will drop in value by about 25%. If you buy (or lease) a $30,000 vehicle, you’ve lost $7,500 in 12 months – that is the price of the splurge. Only you can decide if the peace of mind and reliability are worth the steep price.
Once you’ve determined that new is the way to go for you, and you’ve chosen your make, model, colour and options, it’s time to decide how to pay for it. After looking at your budget, if a key consideration is low monthly payments, you might be attracted to low lease rates.
Leasing, however, is not like renting; you can’t just give it back. Here’s why:
What “Low Monthly Payments” Really Means When You Lease a Car
Many people think that leasing is like renting, but when it comes to cars rather than apartments, there are differences. One of the biggest is cost. Monthly payments with a car lease are made up of two parts; one: interest on the money you borrowed, and two: paying down that borrowed amount (the principal). But the catch is “paying down” the principal, not “paying it off” as you do with a car loan.
In fact, when you get to the end of a lease, you don’t own the car and may only have paid down just over half of its price. Unless you pay off what’s left owing (‘the residual amount’), which could be as much as 40% of your original purchase price, you have nothing to show for all of the payments you made during the course of the lease.
That is how dealers are able to keep the monthly payments low for leases; the principal part of your payment only pays off part of the car, not all of it. The total amount you borrow when you lease is less than when you buy, so monthly payments during the term of your lease are less.
Then at the end, if you don’t pay off the residual amount left owing so that you own the car outright, you’ve essentially paid a hefty amount of interest on what you borrowed to lease the car.
Advantages of a Lease
There are a number of advantages when you lease a car or truck. One of the advantages is that you don’t pay the sales tax on the total amount of the vehicle, only on the amount you are actually using.
Another advantage is that typical leases are about 4 years long, so you could potentially drive a new car every 3-4 years. For some, the extra cost buys peace of mind, knowing that major repairs are under warranty and maintenance is reasonable.
It’s also great that the payments are usually lower than with a loan. If you are going through a transitional time in life and need to keep cash flow as flexible as possible, leasing during this time might make sense for your budget.
Getting Out of Your Lease if Your Situation Changes
A leased vehicle can only be returned at the end of the term, not if your financial situation changes. Getting out of your lease, unless you are fortunate and can negotiate something with your dealer, is difficult. Leasing is essentially paying to borrow the car for a set period of time, and you have to make sure it’s in good condition when you bring it back, e.g. no dents, good tires and brakes, and no cracks in the windshield – or you’ll have to pay to fix those before returning it.
There are also other terms and conditions outlined in your lease agreement, a notable one being maximum mileage. If you exceed the maximum amount of kilometres included in your agreement, the penalty can be significant.
The Bottom Line on Leasing a Vehicle
There are times in life when it may make sense to lease a vehicle, and who wouldn’t want to drive a new car every 3-4 years. Ultimately you need to decide if the splurge is worth it. However, when the rubber hits the road, most people really can’t afford it. Think about it this way, what else you could do with $625 a month for 12 months? Pay off credit cards, save for a trip, top up your retirement savings…the list is endless. In practical, every-day terms, that’s what the $7,500 depreciation cost in the first year amounts to.
For anyone who likes to own their car for a longer period of time, leasing is one of the worst things you can do from a financial perspective. So before you buy, work out your budget, calculate options, know what you can afford, and let the numbers tell the story.