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.