Let me start with this disclaimer: there’s an ideal method of how to approach car ownership based on your circumstances and your priorities. Most of the time, it makes sense to lease. Other times, it makes sense to buy used. Rarely does it make sense to buy new.
With that being said, smart people lease.
In Part 1 (The fundamentals) of this “series,” I wrote that the fundamental building block of understanding and approaching car ownership is to see car ownership as an expense, not an asset. If you didn’t read Part 1 yet, read it now. This article will make a lot more sense after reading Part 1.
When we understand car ownership as an expense, and not an asset, the question is “how much are we losing by having this car, per month?” When you approach the “buying vs lease” question with this mindset, it all becomes much clearer.
It’s also helpful to understand how lease payments are formed. For the sake of saving time and space, read my article here: What Is A Car Lease.
Why do I state that “smart” people lease? What makes them smart? What makes a lease smart? Let’s dig in.
#1 – What is a lease?
Here’s a simple definition. The bank says, “we will let you borrow this car from us as long as you pay the expected depreciation on it along with some interest. After you’re done, give the car back to us or buy it out at the pre-determined buyout amount.”
Essentially, every month, you pay to borrow the car and you pay very little to maintain it.
So your monthly car expense is your monthly payment + gas + normal wear & tear (mostly oil changes and tire rotations). That’s it.
#2 – What are the benefits of leasing?
Low cost of entry – To get the same car, brand new, you would be at a much lower expense for the first three years to get the same product.
To get a used car, at the same monthly cost, you’d be at a much higher mileage and you wouldn’t get the same type of features, creature comforts, and the peace of mind that comes with warranty.
Minimal financial loss – By leasing a car, you will always beat the depreciation because the depreciation is already set. If you had an accident on your leased car, the manufacturer won’t charge you extra for having an accident history. (Make sure any damage is fixed before returning the lease) If you owned a car and had an accident, you take the hit on depreciation.
In addition, whether a car depreciates less or more than the “residual value” states, you can benefit. Few cars can create positive equity in a lease, but when it does, you can have some extra cash at the end of your lease. If your car depreciated more than what your residual value was, simply return it and don’t look back.
Too many Americans buy a car and trade it in anywhere between 3-5 years. That is a waste of money (because you got hit hard on depreciation) AND you paid a lot to buy it within those first few years since you financed it (higher monthly payment + more maintenance than required in a lease).
From a financial standpoint, buying a car only makes sense when you’re keeping it for 6+ years. Otherwise, it would’ve been better for you to lease.
Little to no maintenance – If you commit to a 10k or 12k mile lease, chances are that you won’t ever have to change the tires and brakes on the car. You’d only be doing oil changes and tire rotations.
This means gaining more time to do the things you enjoy (instead of wasting your weekend at the mechanics).
Lastly, car maintenance can be big, one-time, expenses. Tires and brakes can cost you upwards of $1500+. These are costs you need to pay in big chunks. If you have limited cash flow, you can avoid these big, one-time, costs by leasing.
Newest in safety technology – Safety technology will only get better and better. Nowadays, many cars come standard with very helpful safety features. A rearview camera, lane change departure warning, and forward collision detection are among some of the most helpful safety features that come standard, even on many of the cars’ lowest trim levels.
Best in fuel economy – You don’t need to drive a hybrid to get exceptional gas mileage. Many new cars will average 40 mpg on the highway and save you money at the pump.
#3 – What other intangible values do you get by leasing?
Peace of mind – Because you’re fully covered under warranty throughout a lease, you don’t have to concern yourself with major, costly mechanical breakdowns. Life is already pretty messy. Why should a silly machine cause more stress?
Flexibility – While I’m a big proponent of marriage, you don’t have to “marry” cars. Many people shop with the idea that they want to “keep the car until it dies.” That’s not a bad idea and it’s a great way to approach car ownership. But I think life is a bit more unpredictable than that.
What if you have a bad car accident that isn’t considered a total loss? Your car may not drive the same.
What if your car ends up having major mechanical issues outside of its warranty period? You may have to pay heavy repair costs even while paying a loan payment.
Leases give you the flexibility to return the car OR to buy it out at the end of the lease. Again, those who view cars as “assets” refuse to “borrow” a car because they can’t “keep” it. Cars are not assets! They are expenses. Minimize your losses!
Life is short. Drive many cars. – We spend so many hours of our lives inside our cars. I come from the camp that says “life is too short, learn to enjoy everything.” I think this applies to cars.
Leasing is not always a question of luxury and indulgence. It’s more about asking, “how do you want to lose your money in the best way possible?”
If your average loss by buying a car (paying for it, maintaining it, and eating the depreciation) is similar to your average loss by leasing a new one every three years, why not lease? Sounds like the smarter way to go to me.
Let’s conclude this article with two real life examples to show why leasing is smart:
Exhibit A – An owner of a 2016 BMW 650i Gran Coupe bought his car two years ago. After paying about $110,000 after taxes and fees, he wants to upgrade into the BMW M6 Gran Coupe. After just two years of usage, his trade-in value is close to $55,000.
The 650i took a 50% hit on the market after just two years of usage. Meanwhile, if he would’ve leased it, he would’ve leased the car at a protected 60% residual throughout his three years of usage. He would’ve lost approximately $40,000 by leasing it. Instead, after the same three years of usage, he would lose about $65,000-$70,000 by trading in and getting the next car.
Yes, he would get more by selling it privately. And yes, luxury cars depreciate quicker than non-luxury cars. But still, the smarter thing to have done would’ve been to lease.
Exhibit B – Two years ago, a couple bought a used 2006 Toyota Sienna with 96k miles for $10,000 after taxes and fees. 26k miles and two years later, they needed to replace some wear and tear items (suspension, tires, brakes). In addition, the transmission has started to shift weirdly and the car gets abysmal gas mileage (14 mpg).
When factoring in the cost of repairs and maintenance, all in, this couple is up to approx. $13,000 so far. If they sell it after 3 years and 36k miles of usage, the trade in value would be about $2,000 and the private market value would be approximately $4,000, depending on how well their transmission holds up.
But wait, the car was hit-and-run where the car was side-swiped by a truck. This will lower the value of the car to about $3,500.
Let’s say they sold it privately. They would’ve averaged $13,000 - $3,500 = $9,500 / 36 = $263.89/mo in losses. So it doesn’t matter if you buy or lease a car. What matters is your monthly loss on the car. In this case, it’s $263.89/mo. Would it have been smarter to lease a car from the beginning?
This is where some of the more intangible values of leasing comes in: increased safety tech for the family, better gas mileage that would’ve netted extra savings, increased creature comforts like BT audio/phone & back up camera’s, little time lost performing maintenance, less need to shell out large sums of money at a time (suspension alone set them back $1200 on a single bill).
Yes, this couple will end up losing less the longer they keep the car and if the car doesn’t need more maintenance. That was the plan from the beginning. But we come back to the same question as before- why risk long term ownership of a car when you have statistically proven, data-driven reasons to lease a new car and keep it under warranty the whole time, with the flexibility to get rid of it if it’s not a car to keep for the long haul?
For these reasons, smart people lease.
Stay tuned for:
Part 3 – When buying a used car is the wise choice.