40

I have seen many questions asking about leasing vs buying.

I have always bought used cars with cash and have never looked into leasing a vehicle.

I have no idea how they work. Can someone explain how it works and why most users on this site seem to feel that leasing is a bad idea?

Mr. Spock
  • 515
  • 4
  • 7

6 Answers6

63

Leases are effectively renting a car for 2-4 years. You pay a fixed monthly payment (typically after a substantial upfront payment as well) to the leasing company in exchange for the right to operate the car. You don't actually own the car; the leasing company does.

After the lease period is up, you have the option to buy the car outright for a price set at the beginning of the lease. The buyout price is typically higher than the market value of the car, incentivising most people to just turn in the car once the lease is up (and probably leasing a new car to replace it).

They're usually a bad deal because you pay more overall than you would if you took out a loan, and certainly more than if you bought the car outright. There are sometimes benefits to a lease, such as discounts on maintenance, but most often the benefits do not outweigh the additional cost.

They are not used because they're a sound financial way to buy a car; they're used by people who want a new car every few years and can get a more expensive car with the same monthly payment. That's why most commercials for high-end cars advertise their lease price and not their sales price; Paying $400 a month for a BMW sounds better than buying one for $80,000.

If you have always bought used cars with cash, then continue to do so. It is, by far, the most economical way to operate a vehicle.

D Stanley
  • 133,791
  • 19
  • 313
  • 372
  • 7
    Your answer is a bit mixed up. In US leases, if you buy the car, you don't pay excess mileage fees. The buyout is equivalent to paying the original purchase price plus interest, thus effectively acting like a loan. If you return the vehicle at the end of the lease, only then do you pay excess and damage fees. The effective cost is then the depreciation over the lease period plus interest and remarketing fees. BMWs and other luxury cars are advertised as leases because they have relatively low initial depreciation, so lease payments are often less than loan payments. – user71659 Mar 11 '21 at 07:17
  • 5
    @user71659 You're generalizing something that cannot be generalized, even in US. Terms of the lease - again, even in US - vary between leasing providers, vehicles, brands and even the person taking them. – Mavrik Mar 11 '21 at 13:31
  • @user71659 Then why are lease purchase amounts generally higher than the market value of the car? That makes it cheaper to turn the car in and buy a different one (other than the hassle and sentimental factors). – D Stanley Mar 11 '21 at 13:39
  • @Mavrik In the US and Canada, consumer auto leases are always as I described (technically called closed-end leases here or personal contract purchase in the UK). Leases to large businesses, governments and such may vary, but that's not relevant since this is personal finance. I understand that in other countries, consumer leases may be rentals (personal contract hire in the UK), but consumers never have that option in the US. – user71659 Mar 11 '21 at 15:38
  • 6
    @DStanley Where you're wrong is you're thinking of a lease as renting. It's not. A closed-end lease is a loan with a balloon payment and a put option. A higher buyout value is sometimes included intentionally to lower monthly payments, and also generate more interest for the lessor. Also relevant is that the depreciation is determined at the start, and market forces, like gas prices, cause it to vary. Perfect example is right now: car shortages due to COVID have driven prices up so many people are finding it's cheaper to buyout the lease and then sell over a return. – user71659 Mar 11 '21 at 15:48
  • people who want a new car every few years can get a more expensive car with the same monthly payment Isn't that in itself a benefit and therefore a sound financial strategy if driving a new BMW is what you are looking for? (I don't own a car and don't care much, just trying to follow the logic) – Relaxed Mar 11 '21 at 17:29
  • @Relaxed It is, which is a reason why businesses almost always lease vehicles, since they rotate in new cars due to professional appearances, regulations (taxicabs), cost of a breakdown, safety liability, city emissions zones, etc. in addition to taxes and accounting. The argument would be whether an individual needs a new BMW, which for many penny-pinchers is universally no, regardless of the reasons I previously mentioned. – user71659 Mar 11 '21 at 18:04
  • @Relaxed Not if that low monthly payment comes with a huge balloon payment after 4 years. In the long run borrowing to buy a core is much more economical. – D Stanley Mar 11 '21 at 18:10
  • @DStanley Exactly the opposite. Leases have payments that follow depreciation, whereas loans use constant payments over a longer period which results in you being underwater (in most cars) during the initial period. Thus a lease results in more money being paid off sooner and lower overall interest, if the rates are equal. If interest rates are following the market and are identical, cash is cheaper than a lease which is cheaper than loan. If interest rates are highly favorable, (e.g. 0% due to subventing), then the order is reversed. – user71659 Mar 11 '21 at 18:22
  • Do you have sources for "usually a bad deal because you pay more overall" and for benefits not outweighing the costs? – spacetyper Mar 12 '21 at 07:43
  • Also just want to say that anecdotally leases have a few big advantages you don't mention: 1. Accidents aside, you're almost guaranteed to have no surprise costs over the lease duration. 2. The car is going to be reliable. 3. If you're unsure how long you'll want the car for, you don't have to deal with hassle of selling. 4. Cars depreciate like crazy, so unless you want to drive it into the ground you'll "lose" money selling. 5. You can usually sell your lease early if needed and sometimes make money. – spacetyper Mar 12 '21 at 07:51
  • The buyout price is typically higher than the market value of the car, Agreed with @user71659 - there is certainly a risk of this if you walk into a lease blind, but it's also possible to lease strategically without necessarily paying a significant premium. If you're paying attention and don't let the dealership drive the negotiation it's possible to get reasonable lease terms with a good buyout price at the end. I bought out a lease five years ago for about 10% below market. The wife's car is up for buyout in a few months and, looking at used vehicles, it'll be more like 20% below market. – J... Mar 12 '21 at 11:52
39

D. Stanley has correctly described the process, but not a significant implication and a reason that many people do choose to lease.

If you use your car for business, the cost of leasing is probably considered an operational expense, and can be fully deducted from your sales. If you buy a car, you now own a piece of capital equipment, which not only has cost you a larger outlay up front, thus reducing your cash assets, but the cost of which can only be depreciated by a certain amount over a period of time (usually annually). Also, the residual value of the vehicle must be accounted for when you finally dispose of it.

Please note - I am describing general principles, I am not an accountant. If you will be using a vehicle other than personally, consult one to see how this might effect your business.

MickeyfAgain_BeforeExitOfSO
  • 539
  • 3
  • 7
  • 8
    Well, this is a personal finance site, so that is not exactly a significant oversight in the other answer. – Najel Mar 11 '21 at 13:35
  • 1
    Whether a lease expense or depreciation will grant a preferable tax result will depend on jurisdiction. In particular, a business choosing to buy a car or lease it, would likely need to incorporate the impact of borrowing funds to buy the car, and consider the interest expense impact of doing so. – Grade 'Eh' Bacon Mar 11 '21 at 14:36
  • 11
    Yes, @Najel, personal finance site, but there are many entrepreneurs that would find that information helpful. – Mark Stewart Mar 11 '21 at 14:48
  • 7
    @Najel in the case of a United States based person with a sole proprietorship or significant income reported on Form 1099, their personal income is exactly business income. – user662852 Mar 11 '21 at 15:00
  • 1
    If you are in a profession where the image of driving around in a fancy new car is beneficial to you (sales comes to mind), leasing also gives you an easy way to do so. You don't have to mess around with selling your car and buying another one, you already have a built-in process for turning it in after a few years and getting another one. Sometimes there is business benefit in keeping things simple even if it costs a little more money. – Seth R Mar 11 '21 at 17:02
  • 1
    There are 2 other scenarios that also make leasing a car a wise option. 1) My grandfather just leased a car because he expects to only drive for another few years before his sight fails him or passes away. He would prefer not to leave his wife with a car payment or asset she would then need to sell. Along the same vein, 2) My friend also leases a car because he intends to move to NYC in 2 years where he will not want a car. Same issue as above - why take a multi-year loan for a car you will need to sell a few years down the line? This is quite similar to the renting vs buying a home argument. – dberm22 Mar 11 '21 at 18:01
  • 1
    @dberm22 Two other common scenarios: 1) you want a small economy commute car or sports car now, but are concerned you will need a minivan when you start a family and 2) an up-and-coming one, you are interested in an electric vehicle but are concerned charging won't work out for you – user71659 Mar 11 '21 at 20:19
20

I like this question because I think leasing gets a bad rap as being a rental and renting is bad so don't lease. I, personally, have never bought or leased a new car, but leasing has it's place. One blind spot of the other answers is sales tax. Depending on your jurisdiction, buying a car isn't different than buying anything else and you'll owe sales tax.

In some places, like California, when you buy a car, you'll owe sales tax on the whole purchase price but when you lease a car you pay sales tax on the lease payments. California also has no other way of mitigating the sales tax. A number of states will asses the tax on the purchase price net-of a trade-in or other similar mechanism.

If you're buying an $80,000 BMW, and the sales tax is 9% that's $7,200 in just sales tax, due right now. This obviously gets worse if you do a zero down financed purchase of a car, now you're paying interest on sales tax, don't do that ever.

When you lease a car, you and the lessor agree to some amount of depreciation that will take place over the lease period to cover your use of the car. A rule of thumb is about 35% for 36 months. So rather than buying the car for $80,000 you're agreeing to pay the $28,000 of depreciation the car will experience. You agree to a usage limit, like 30,000 miles over the three years. You agree to keep the car maintained and in good shape; meaning you fix dings, dents and other damage. To that end the leasing bank may require you to keep very low deductible insurance. You also agree to fees if you don't keep up your end of that bargain. The lessor agrees to sell you the car after the lease period for the $52,000 remaining after the depreciation, this is your buy out price. After you add an interest rate (money-rate in lease jargon) and fees to the $28,000 of depreciation you'll pay something closer to $3,000 in sales tax over the course of the lease, and you don't have to pay it now.

It's for this reason that essentially all exotic cars you see, particularly in high tax areas, are leased. No one is parting with a $25,000 (or whatever) tax bill to pay cash for their Ferrari. Similarly, of you want to be in that new $80,000 BMW every three years in CA, you're not paying $7,200 in just sales tax every three years, you're leasing it.

With that in mind, some cars "lease well" which means the financing bank assumes a small amount of depreciation, while other brands/banks are more "lease to own" where a lot of depreciation is assumed and you'll have a lower, generally below comparable, buyout price at the end. As D Stanley points out, the cars that "lease well" will have a high, generally higher than comparable market, buyout price when your lease is over. To some extent, cars that lease well also incentivize you to lease your next car too. So when you're shopping pay attention to the residual value, different brands/banks treat this differently. If a Mercedes, BMW, and Audi all have an $80,000 sticker price and the same money rate of interest, they'll still have very different lease prices because of this difference in depreciation philosophy.

The sales tax issue is more like salad dressing than a meal in terms of benefit, and is really only something to consider after you've decided you're going to spend the money to be in newish cars every few years.

Assuming this is not a business expense, because leases have bookkeeping benefits in that context, it's probably more financially sound over the long term to buy well negotiated used or certified pre-owned cars, and never ever include fees or taxes in the amount you finance. Whether you're leasing or buying, the car is still going to lose 30-40% of it's value in the first 3 years. Generally, the only way to win with cars is to keep them for a long time. Newer, more expensive, cars command more expensive maintenance and repairs, more expensive insurance, and you eat depreciation for breakfast lunch and dinner. Whether you're paying interest on a loan, or a money rate on a lease, renting, or ubering everywhere, or whatever; a car is an expense. And, probably, the best way to minimize the expense of being in a new BMW every three years is to lease it. But, generally, the best financial move is to avoid the first few years of a car's life.

quid
  • 48,976
  • 11
  • 99
  • 161
  • 1
    I'd also add that leasing makes the most sense for electric cars right now, since the tech is advancing so fast, that by the time the lease expires in ~3y, the models available on the market will be substantially better in terms of core usability than your old car. +(this applies to the US only) the Federal Tax Credit get rolled into the lease, you don't have to have to wait until the end of the year or have paid $7500+ in net income tax to benefit. – Eugene Mar 11 '21 at 17:58
  • Speaking of dings and dents: My auto lease has a clause where there's a certain amount of damage they'll just forgive at the end of the lease. I've never had a problem returning a car even when the alloy wheels have been scuffed. (Plus, they want you in their next car, so you can even negotiate that.) – davidbak Mar 11 '21 at 21:15
  • One other factor I'll mention here - that I haven't seen mentioned elsewhere - is that you have less opportunity to customize your vehicle after you drive it off the lot. You can get whatever mfr or dealer accessories you want, sure, but if you want an aftermarket dashcam installation (or music system I guess) you either can't or have to get approvals and lease changes or something. (If that's even possible.) – davidbak Mar 11 '21 at 21:18
  • @Eugene - that's why I started leasing over buying used and keeping cars about a decade, which I had been doing. About 15 years ago I thought that safety electronics were beginning to advance so fast that I didn't want to keep a car 10 years anymore - I wanted to be able to upgrade every 3 years to take advantage of new safety technology. Seems to have slowed down recently though so I may very well buy my next car ... – davidbak Mar 11 '21 at 21:19
  • 2
    "Depending on your jurisdiction, buying a car isn't different than buying anything else and you'll owe sales tax." Why would it be? Where is it not taxed? – Azor Ahai -him- Mar 11 '21 at 22:02
  • @AzorAhai-him-, I don't know, that's a caveat I put in answers to avoid people saying that in this or that state or country cars aren't subject to sales tax. However, different states DEFINIELY treat taxation of cars and car registration very differently, I don't have a list of the various difference though and some of those may involve sales tax liability. I believe WI is an example of a state that allows a tax credit based on trade in value; which does reduce ultimately mean you are not paying sales tax on your whole new car; CA, and many other states, do not allow such a credit. – quid Mar 12 '21 at 01:27
  • And regarding advances in technology or whatever, the reason leasing makes sense is because you'll win on the sales tax. You can always buy an sell something in 3 years, the issue is paying sales tax on 100% of that thing with no way of recouping it, every three years. It's the constant outflow of sales tax, and to some extent the transaction friction of negotiating trade-ins, that makes leasing a preferred way to routinely swap in to new cars, no matter the reason. Though, I agree that for the case of electric cars, the $7,500 government intervention is it's own criteria to consider. – quid Mar 12 '21 at 01:50
  • 1
    Lease payments and car sales are both subject to sales taxes. Over the lifespan of a typical car, you will pay less in taxes by purchasing than continually leasing equivalent cars over the same period. Even if you trade-in your car over a shorter timeframe, most states calculate sales tax at net cost (i.e., after trade-in). – Jacob Budin Mar 12 '21 at 02:37
  • @JacobBudin, thank you for restating what I wrote in the answer. – quid Mar 12 '21 at 04:43
  • @AzorAhai-him- In a number of states, a car is not subject to sales tax, or is otherwise subject to a lesser alternative tax. This is because cars are property taxed, so in these states they do not fall under sales tax statutes to avoid double taxation. (Similar reasoning applies real estate, airplanes, boats) For example, GA has a 6.6% Title Ad Valorem Tax instead, SC has 5% with $500 max Infrastructure Maintenance Fee, and sales-tax free OR actually has a 0.5% privilege tax. – user71659 Mar 12 '21 at 05:59
  • Nobody has mentioned a key feature of leasing, which is convenience. Assuming you are solvent enough to satisfy the loan requirements, you basically sign a form and drive away a new car. You have none of the hassle of buying and selling at either end. If the excess cost is within your budget, it's a fairly pain-free option. – Oscar Bravo Mar 12 '21 at 13:08
  • @OscarBravo Because that's not true. The vehicle purchase price is negotiable in a lease, just like a loan or cash purchase. If you want to take the dealer's first offer, that's an option in all three cases. In fact, it's easier to pay cash since the only factor is purchase price. In a loan the interest rate has to be resolved (e.g. shopping between banks and captive finance), and worse, in a lease, the residual value and turn-in fees are now another variable. – user71659 Mar 12 '21 at 18:47
2

First off, lease=long term rent, just as it does with housing. You do not get any equity in the item, and you are generally less responsible for maintenance. You may have an option to buy at the end of a lease, but that is not a given. If you have an option to buy, it may be at a reduced price or it might not.

If you’re rich, you buy the car outright and then dispose of it whenever you want to as the amount is irrelevant. If you are poor, you buy used and hope for the best, if you’re middle class you buy new and then plan on keeping it for at least a few years after paying it off.

But if you’re well off, but not quite rich, leasing a car can makes sense if you want to use a new vehicle without worry about maintenance expenses. The thing is, if you buy a car, no matter how well you do the routine maintenance you are liable to eventually either need to preemptively do a major repair or deal with the vehicle being inoperable for a period of time. If you lease a new vehicle, you will need to do very little routine maintenance (which should be covered as part of your lease) and should basically have no downtime. Leasing thus allows you to have a new car at a constant expense. If you can afford the expense, it is an easy way to manage things.

jmoreno
  • 1,355
  • 8
  • 15
1

I leased a scion tc for 2 years. I was in graduate school and I did not know how far I would be going once I graduated (so I did not want to buy a car then have to drive it). Over those two years I payed around 6k. The car ended up depreciating about 8k in the time I had it. So In a sense I came out ahead. Also It was in an accident that required 10k worth of repairs (which the insurance picked up). But I am sure that would also have depreciated the value of the car if I had had to resell it. Of course for 6k I probably would have been able to buy a decent used car and I would still have that now.

ivan viti
  • 11
  • 1
  • 6k might buy you the second hard cat but remember that it will likely need repairs in that time, and will also lose value. – Jack Aidley Mar 12 '21 at 19:44
  • 1
    That car depreciated 8k, but did you buy a more expensive one because of the lease? I don't have a car, but I know someone who bought a used car for about $2k (equivalent currency) and it runs just fine. For your lease payment you could've gotten 3 of those and thrown them in the scrap heap. – user253751 Mar 12 '21 at 20:18
0

Congratulations on always buying used cars. You have saved big money by avoiding the huge depreciation of a new car. One additional choice that was a new concept maybe 30 years ago, was a blend of a conventional loan, and a lease. It was a loan with a huge balloon (final) payment. That allowed a lower monthly payment that was promoted to compete with the lease's lower monthly rate.

The car dealer could then convince the purchaser to trade-in the car before the big balloon payment. In practice, that often lead to negative equity value on the trade-in. It was promoted of all the advantages of ownership and leasing. I called it all the disadvantages of both. Now that is such a common option, you just need to be sure to ask if there is a balloon payment.

Mark Stewart
  • 157
  • 1
  • 10