[ad_1] Recently, a reader named John wrote in asking about leasing vs. buying a car. Here is John’s question: I was wondering what your input is in regard to buying vehicles? For example, I’m in the process right now of selling a vehicle for a good buck. Would you suggest reinvesting this money in a used vehicle selling for a small price with low mileage? Or would you suggest leasing? Overall, every vehicle depreciates once you make the buy, so what would the be the best decision here? Leasing or buying used? It’s a question I hear a lot. Monthly lease payments can be a lot lower than the payment on a loan to buy the car. While this can make leasing look more attractive, leases are rarely a good deal. Let’s break John’s question down first, and then we’ll look at the pros and cons of leasing vs buying. John’s question is really two questions folded into that one. You can pay cash for a car whether you lease it or buy it. So the first question is this: Are you going to finance the acquisition of a car – whether you lease it or buy it – or are you going to pay cash? My strong preference is to pay cash for a car. And those that do pay cash, almost always buy the car. If you do plan to finance the acquisition, we move to the second question. Should you finance the car with a lease or with a more traditional loan? The way that we’ve broken this down underscores an important point. Leasing is a form of financing. A lease is just another way of financing the acquisition of a vehicle (unless you pay cash for the lease, which nobody does). There are significant differences between leasing a car and paying for one with a loan. But just keep in mind that a lease is a way to finance a car. Should you just pay cash? If you’ve followed this blog and my podcast, you know I’m a big believer in paying cash for a car. In most cases, for that reason alone, I don’t think leasing is a good option. Most people who either lease or borrow to acquire a car end up gettng a car that’s more expensive than they can reasonably afford. I’ve certainly done that in the past. I’ve never leased a car, but as I look back on the cars that I’ve purchased, when I was borrowing to buy a car, I ended up spending more than I should have. And when I pay cash for a car – like the last Toyota Camry I bought – the fact that I paid cash for it absolutely effected how much I spent. As I was looking for cars and thinking about the money coming out of my bank account, it really put the brakes on overspending. The best way to get a car is usually to pay cash. How do leases work? Let’s talk about how leases work a bit. There’s no single form of lease, but there are certain standards that you’ll see most often. Typically, a lease is for three years. You can get one or two year leases, but most are for three years. In addition to the length of the term, there’s a limit to the number of miles you can put on the car. A standard mileage limit is 12,000 miles per year. So in a three-year lease, you’d have a total limit of 36,000 miles. You can drive it more than that, but once you go over the 12,000 miles per year (or however many total miles your lease states), you end up paying a fee for each additional mile over the limit. From what I’ve seen, the fee typically comes in at around 20-25 cents per mile. If you put an extra 3,000 miles a year on your car – which isn’t hard to do – that could add an extra $750 to the lease at a 25 cents per mile rate. So it’s essential to understand mileage limits. And at the end of a lease, you either return the car or purchase it. How are lease payments calculated Lease payments are calculated using the purchase price, the residual value of the car at the end of the lease, your down payment, capitalized fees, and what is called the money factor. It’s really not complicated, so let’s walk through the steps. The first thing they’ll calculate is the residual value of the car at the end of the lease. On a three-year lease, for instance, they’ll calculate what the car will be worth at the end of three years. The formula usually involves a percentage of the new price of the car, which varies from car to car. As a rule of thumb, though, you can assume that after three years, the car’s residual value will be about 50% of the new value of the car. (Although this will be higher with some cars.) The residual value is then subtracted from the price of the car to arrive at the car’s depreciation. If you have a $20,000 new car, for example, at the end of the three years we’ll assume it’s worth $10,000. It has depreciated by $10,000 during that three-year lease. And that’s the portion of the car you’ll pay for – this loss of value over the term of the lease. But there are other factors rolled into how your payments are calculated. For instance, there are fees and taxes associated with a lease. There’s also what’s called the “money factor.” This is basically interest associated with your monthly payments, and it can be significant. So when you factor in the depreciation, fees, and “money factor,” then divide that by the number of months in your lease, you’ll get your monthly payment. You can lower the monthly lease payment by making a down payment, similar to buying a car. Key factors in
