In recent years, car leases have become more common. Some estimates peg that 33% of all cars coming off dealers’ lot will be leased cars. If everyone jumped off a cliff is leasing a car, why is it a terrible idea?
A primer on car leases.
The best way to explain a car lease is basically you are renting a car for an extended period of time over years rather than days or weeks. Similar to buying a new car, you go into a car dealership to test drive the car and negotiate the price of the car. For leases, the price of the car is known as the capitalized cost. The major difference between leases and buying a car is you will also determine the price at which you will return the vehicle or residual price. From there, you pay monthly payments for your car on the difference in depreciation of the vehicle and the original price of the vehicle. You can also expect to pay additional fees, interest, and other costs that vary by contract.
As an example, if your capitalized cost is $30,000 and your residual price at the end of the 2-year contract is $15,000. At the end of the contract, you will pay at least $15,000 (+ fees + interest+and other costs) over 2 years.
Benefits of car leases.
Before I get into my usual shtick of telling you why car leases are the second worse thing since Nickelback, there is a reason for car leases becoming more popular. Here are the major benefits of car leases:
1. Relatively smaller monthly payments. This is probably the top reason why anyone would get a car lease. Because you’re paying a fraction of the car, your monthly payments are going to be relatively smaller than buying a car with a car loan.
2. Relatively smaller down payment. Similar to the reason for smaller monthly payments – smaller amount owed, smaller down payment. Expect a down payment to range from $1,000-$4,000 dependent on the car you buy.
3. You can change your car at the end of the lease. Probably the most attractive option for people who would prefer getting a new car every couple years. It is also an attractive option for people who tend to use newer cars for their business (Uber, Lyft, Real Estate, etc.)
4. Covered car maintenance. I don’t personally think this is a pro. People who lease swear up and down that the car maintenance by a trusted dealer cannot be undervalued.
Fairly un-biased negatives of car leases.
1. Restricted mileage. Depreciation is calculated by how much you drive. You must always keep aware of how much you’ve driven your car. If you pass the mileage amount, you will pay a penalty at the end of the lease. This personally ranks high on my list of why not to lease, so more on this later.
2. Insurance is more expensive. Due to additional risks, car insurance is generally more expensive with a leased car. There is additional insurance that you pay on your monthly lease.
3. No ownership of the car. Similar to renting an apartment you do not own the car, which means you can’t trade in your car.
4. Penalties at the end of the lease. Mileage penalties, dings and pits, etc., you will need to pay for all these issues at the end of a car lease.
5. Restrictions on where you can drive and where to drive. Most leased cars have a clause that does not allow you to drive out of country without permission. There are also restrictions on using it for business (i.e. Uber and Lyft).
Why you should avoid car leases like the plague (with my biased takes – duh).
I am a strong believer in controlling your own financial destiny. When you decrease your future risk, you are more in control of your own financial destiny. Car leases do the exact opposite of decreasing future risk. At the end of the lease, whether you are charged additional fees and penalties is completely in the hands of the car dealership. That minor fabric fraying? No prospective buyer of your used car will care, but you know who will? The car dealership. Leasing cars are the cash cow of car dealership and they will attempt to milk you for every last dollar.
Why the car dealership makes more money leasing.
The hierarchy of how much profit gained by a car dealership: leasing cars, selling used cars, selling new cars, and car repair. Leasing is profitable to dealerships because the person leasing the car is taking the hit for the largest depreciation in value of the car. Cars lose the most value in the first 2 years of their life; leases last about 2-4 years. Once the car comes back to the dealership they are able to sell the used car in excellent condition at a high price. They do that by putting penalties for any damages. If any damage is done, the value of the damage is guaranteed to be higher than what it should be.
Not only conceptually leases are more expensive, car dealerships make sure they are profitable through contract jargon. Contract fees, additional penalties, maintenance of the car are all packed into the monthly payment of a lease. To make it harder for you to understand, jargon is thrown at you. On top of this, dependent on where you go, the capitalized cost (or full price of the car) may not be negotiable. Lastly, car leases are notoriously hard to get out of, which does not give you much flexibility.
The bottom line of leasing a car is you are putting yourself in a risky situation for very little gain.
What should I do instead?
Buy yourself a used car in the your budget range even if it’s a crappy car. Even better, buy yourself a car beneath your budget and work yourself to a better car. Then, use that crappy car to motivate you to get a better car. When I was driving a crappy car, it was a reminder everyday that I was working to get out of my situation. You might even get people to feel bad for you – I used my crappy car to successfully convince my supervisor I needed a raise.
There only situation where it’s remotely feasible to lease a car is if you plan to live an area for the next 1-4 years where it hard to drive your car to your next destination. An example of this would be going overseas/Hawaii for schooling or contracted work. Even then, I would highly suggest doing the math of whether going the crappy car route and selling it back is better. Cars provide little residual value – leased cars are guaranteed to provide no value. Rather, leased cars only provide future financial risk. It helps reinforce the bad habit that you can afford something when you actually can’t.
The problem of why most Americans are in such a financial pickle is because it is easy to buy into an illusion of affording something you can’t afford. This illusion begins to play out in other parts of your life as well. Oftentimes, I find people lease cars for the sake of buying a new car to look good in. If you’re going to lease a Benz, you can’t possibly dress in clothes from Walmart. So, you end up buying clothes on credit to look the part which is part of the entire vicious cycle of debt.
Do future yourself a favor. If you prefer financial stability, under little to no circumstances you should ever lease a car. If you like the endless cycle of debt or enjoy wasting money then go ahead and lease your car. The car dealerships will thank you.
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