Demystifying the lease vs buy decision

'Lease vs buy' is another fundamental decision you'll need to take, when acquiring an automobile in America. One caveat, though.

The best leasing deals in the market are usually for new cars. The older the car, the lower its residual value, and the greater the risk for a leasing company. Hence, this section would be more useful for people thinking of getting a new car.

So what is leasing and how does it differ from buying?

Both leasing and buying are ways to finance acquisition of a car (or anything else, for that matter). When you 'buy' an automobile, you finance it by taking out a car loan. The bank or financier pays off the dealership in full and charges you a down payment plus monthly instalments. The monthly instalments comprise a principal component and an interest component. Once the loan is paid off, the car is yours to keep. When you 'lease' a car, you are paying for the right to use it for a fixed period. Think of leasing as a long-term rental. The car is owned by the leasing company but is exclusively yours to drive and maintain during the lease term, and against fixed monthly payments. At the end of the lease term, you return the car to the dealership (or exercise the option of buying it from the leasing company at that time).

Psychologically, buying a car seems a more comfortable idea. You want to own 'your' car, not drive a leasing company's car. But if you think about it a little, leasing is a very viable option. Here's why.

Unlike real estate, a car is a depreciating asset. That means, it loses value over time. So when you buy a car, its worth less with every passing year (this is called its residual or salvage value). Eventually after say 12-15 years, it'll be worth nothing but scrap value. At that time, you don't really 'own' anything. All that happened was you enjoyed your car for 12-15 years. The price you paid for it was really the cost of usage - exactly like a lease! "Owning" was just a concept in the head!

So back to the original question - lease vs buy? The answer depends on your time horizon and personal preferences. Here is guidance from our readers, the crowd that's been-there-done-that :

Lease vs Buy: In favor of Leasing

• When you lease a car, your monthly payments are lower. This is because you're not buying the whole car, you're only buying a period in the car's lifetime. So if you're balancing your budget and want to keep monthly outflow low, you're better off leasing in the lease vs buy decision.


• As a corollary to the above, a lease enables you to acquire a bigger and better car for the same monthly payment. For instance, if you take out a 5 year loan with 10% down for an amount that buys you an Acura, you'll probably be able to lease an equivalent Mercedes in the same monthly payment. So if you're dying to get that fancy car, that's just out of reach, leasing will bring it within reach.


• If your time horizon is no more than 2 to 3 years, lease. In the short run, leasing is cheaper. So if your job location might change, or if you like driving new cars and would anyway replace your car every 2-3 years, leasing is the way to go.


• If you don't have the time or inclination for car maintenance, you might want to lease vs buy. Since you would typically lease a car for 2-4 years, return it and then get a new one, you'll probably never face significant repair and maintenance issues. If, however, you buy a car and keep it for the long-term, you'll have to spend time, money and effort on maintenance, especially in the later years.


• With a leased car, you don't have to worry about trade-in values and how to dispose off the car, when its time to replace it. You just hand in the keys to the dealer when the lease term ends.

• If the concept of ownership is important to you, by all means, buy.


• Leases are not just limited to a fixed duration, they are also capped to a maximum mileage. Most leases are for 10,000 or 12,000 miles a year (the average mileage of an American). Some go up to 15,000. But if you anticipate driving your car more than average (perhaps you do a lot of out-of-town trips, or perhaps your place of work is far or perhaps you have only one car), buying might be better. If you exceed your mileage limit on a lease, the extra miles are charged separately at high rates.


• If you plan to keep your car for the medium-term (say 5 to 8 years), buying is cheaper. By this time, you would have paid off your loan (most car loans are for 3 to 5 years) and you would have no further monthly payments. With a lease, you have to keep making monthly payments for ever, because you never really 'own' a car.


• If you lose your job or otherwise need to break your lease, lease breakage penalities are very high. In most cases, you would need to pay the full amount contracted under the lease, irrespective of whether you keep the car for the lease term or not. If you buy the car with a loan, however, the car is 'yours'. You can sell it, and pay off the loan anytime. You will still suffer some loss, but not as much as with a leased car.


• If you like to customize your car (a turbo engine, bigger wheels, tailpipes and so on), there might be restrictions under a lease. But if you buy the car, its 'yours' and you can do what you like.

One important point before concluding. I had mentioned at the beginning of this section that leasing is generally more prevalant for new cars. It is however possible to lease used cars as well. There are sites on the internet that allow you to swap into pre-existing leases. The site would match you to another party that wants to get out of a lease. You can negotiate good terms for the remaining period of the lease term. If you're on the other side (i.e. you have a lease and need to get out of one) the site would work equally well for you to reduce your lease breakage liabilities. Check out: www.swapalease.com

www.leasetrade.com

So how does one wrap up the lease vs buy debate? As with most things, it depends on your personal situation. But here's an idea that's worked for me: if you have 2 cars, buy one and lease one (usualy the more expensive one)!

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