Leasing a Car? Know the Downsides

by Lee Distad

For many people, car ownership is the second biggest ticket purchase that they’re likely to make (after real estate). No matter how you slice it, a car is a substantial purchase.

My late grandfather was fond of pointing out that every vehicle he purchased in his lifetime cost as much as all the previous ones put together. As a child of the Great Depression Era, he was incredibly debt-averse, and paid cash for all of them.

However, because a car represents such a sizable purchase, most people choose to finance them rather than pay cash.

For personal vehicles (as opposed to ones for work), buying has a number of advantages over leasing. Here are some of the disadvantages inherent in leasing a vehicle for personal use.

You’ll Never Stop Making Payments

Unlike paying off a car loan, where one day you’ll make your last payment and the car will be your property, leasing is just like paying rent.

When you finally return a leased car, your relationship with it is over. All you’ve received for your money is its time and use.

Some leases are open-ended with a buyback option, but I’m not keen on them. By the time your lease ends, you’ve already paid a substantial amount without earning any equity. The buyback balloon cost at the end is often uneconomical.

I haven’t even mentioned that vehicles depreciate over time. But once it’s paid for, it’s a possession that still has some value attached to it.

Extra Charges For Mileage And Wear

With most closed-ended leases, you face extra costs for higher mileage and greater-than-normal wear and tear.

For grocery-getters and pleasure-driving vehicles, that may not be an issue, but for a daily driver, in the long run you may well be better off with a loan instead of a lease.

With No Equity, You’re Out Of Luck if it’s Totaled

My primary beef with car leases stems from personal experience. If you’re in an accident that totals your vehicle, the insurance company pays off the bank, not you.

We once chose to lease a vehicle that was t-boned and totaled in an accident (thankfully there were no serious injuries). But we needed a new car, and the insurance claim left us with no vehicle to trade in or lump sum of cash to make a down payment.

At that time, we lacked the resources to pony up a large down payment on our own. So, without a trade-in and no down payment, the monthly payment on our replacement vehicle was substantially higher than we would have preferred.

Hardly a life-or-death situation, but it was a drag nonetheless.

Too often, people make financial plans based on best-case scenarios. Well, in order to plan and budget effectively, you need to face the worst-case scenarios also. Ask yourself, “If I lease a vehicle, and it has to be written off, will it be a material hardship to acquire a new one?”

If the answer is yes, consider a traditional car loan instead.

As they say, your mileage may vary. Make informed financial decisions after weighing your options and looking at both the pros and the cons. And if you’re buying, be sure to take advantage of a trade-in allowance (like cash for clunkers), make a substantial down-payment, or both.

Lee Distad consults with CE integration firms on design, installation and project management processes and Best Practices, and offers provides professional copy writing services for websites, brochures, and marketing initiatives. His freelance work covers topics from CE to global business to finance in both print and online.

{ 3 comments… read them below or add one }

Jason Schultz August 5, 2009 at 12:54 pm

Mr. Distad, I feel your assessment of leases is a bit biased.

When you lease a car you are effectively paying for the portion of the value you use up for the time you have the car.

Consider this simple example (I have ignored the time value of money for simplicity sake)

Person A ? buys a $48,000 car, keeps it for 4 years and sells it for $24,000 to an arm?s length buyer

Person B ? leases the same car for 4 years for $500 per month (48 * $500 = $24,000)

So who is better off? Over the 4 years both person A and B are out of pocket the same $24,000.

So with respect to your arguments

1. You’ll Never Stop Making Payments ? this is true for both buying and leasing a car. If you want to continue to have a new vehicle after the 4 year period Person A will have to buy a new car, and person B will have to enter a new lease.

2. Extra Charges For Mileage And Wear ? again, you fail to take into account this would have on person A when he sold his car, would you pay the same price to buy a 4 year old car with 100,000 km as you would for one with 200,000, or 40,000, the answer to this question is invariably no. The mileage and wear and tear would impact the residual value of a leased car in the same way, since a lease is based on a pay for use premise, if you use more than is assumed in the initial calculation of payments, you should pay more of the value.

3. With No Equity, You’re Out Of Luck if it’s Totaled ? well technically you are only out the portion that you used. You mention that you don?t have a down payment for the next lease, and that your subsequent payments were higher. They way a lease is structured if person B pays a down payment of $12,000, their payments will be $250, but at the end of the lease, they will be out of pocket roughly the same amount (12,000 + 48*$250 $24,000). If your lease came to term, you would turn the vehicle in, and would not have a down payment for the next lease either

In addition to the above, other benefits of the lease include not having to worry about maintaining a vehicle as oil changes etc are often included in the price.
In summary, I don?t want to come off as pro-lease, as the accountant in me advocates doing a fair and unbiased analysis. There are some very simple tools in excel that allow you to calculate what the Net Present Value (NPV) of each option would be. An NPV analysis factors in the time value of money. In other words if you gave me $100 today, I would be better off than if you gave me $100 a year form now as I could invest the $100 for a year and earn some interest. By learning these tools you can ensure that you are getting the best possible deal, as when a lease is structured properly, the NPV should be the same, and you should be in the same financial position regardless of your choice. As always, this is a case of caveat emptor, as you need to know what you are signing up for.

Jason Schultz, CA

Lee Distad August 5, 2009 at 3:10 pm

Those are great points, Jay. I appreciate your perspective!

American Banking News August 10, 2009 at 6:39 pm

Interesting perspective. My strategy has been to purchase ~$5000 vehicles, keeping them for about 3.5-4 years, and then selling them and buying another equally cheap vehicle. This way, the amount of depreciation I’m hitting is a lot less than it would be if I had purchased new vehicles.

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