#59 - Is it Better to Lease or Buy a Car? Low Inventory Inflates Prices and Impacts the Budget

Updated: Jun 11

-Why do people lease a car? -Common advantages to leasing -Common disadvantages to leasing -Weighing the lease vs. Buy option with math -The recap and personal finance tips Is it better to lease or buy a vehicle? This is a great question as it depends on what your motivation is and what patience level that you have. So let’s Start With Buying a New Car Car prices are on the rise and according to CNBC the average price for a new car is $39,950. This is more than the average balance of student loan debt which according to US News was just over $30K through 2019. That is expensive! Keep in mind that the car payment is just one factor in driving a vehicle: there is maintenance, insurance, plate fees and gasoline. The chip shortage (2021) is causing a low inventory of vehicles and with high demand, it is driving up the prices. This is the same thing that is happening with the housing industry. We mentioned this in Podcast PFT #20 When is the Right Time to Buy a House. The process is pretty simple: this is a consumer loan based on amortization. You take the balance, apply the interest rate and you figure out the loan term. From there you pay the same amount each month just like a fixed mortgage payment. As you pay the loan down the interest decreases and the principal increases. Why Do People Lease? It is a no-brainer as to why people lease: they are getting the latest and greatest with features, styling, technology and safety. Right off the bat leasing typically comes with a smaller payment to that of buying a car with the same value. The reason is that you are paying for the residual value of the car; meaning, you are responsible for the amount of money that the car will lose. Keep in mind, the minute you drive off the lot, you’ve already lost money. For example, if you leased a car for $38,000 for three years; the dealership’s finance arm or banking institution determines what they feel the amount of depreciation will occur. So if the car loses $20,000 in value over a three-year lease term, then this is the base principal that you will be responsible for plus finance charges. Common Advantages to Leasing As we mentioned before, you get the latest and greatest with more updated technology in the car. This can prevent consumers being priced out of the same features that come with a new car. Meaning, I may not be able to afford to buy the new car with these upgraded features. Being that the car is new the warranty will be fresh. This means there is no worrying about unforeseen repairs that can hinder that can tap into the budget. The lease may also come with some free maintenance such as oil changes or tire rotations like mine did. You get the Steady Eddie with the same monthly payment. When the lease is over you simply drop the car off. Common Disadvantages to Leasing You will have a payment in your budget that never goes away. Hence, there is no achievement of ownership. You are stuck with the car payment. If you have a financial hardship or simply do not like the car, removing that obligation can come with penalties and termination fees that can be costly. In addition, the money is due immediately. The vehicle needs to be returned in good condition meaning within normal wear-and-tear. Therefore, if you have scratches, dings and carpet stains you may be on the hook for the maintenance. This leads into understanding what the maintenance obligation is: this may include tires (needs to be the original type of tires on the car) brakes, repairs and operating expenses. In tandem is that tricking out the ride with aftermarket modifications typically are not part of the contract. Therefore, there will be a requirement to return the car the way that it left the showroom. Watch out for mileage. Lease contracts have a number of miles that are allowed during the lease term. If you go over this number charges will be assessed on a per mile basis. For example, for every additional mile outside of the agreement it will cost .25 per mile. Hence, it is important to gauge how many miles that will be driven during the lease term as the dollars can add up. Weighing the Lease Vs. Buy Option With Math When doing the math, leasing often costs more over the long-term when compared to an equivalent loan; meaning two three-year leases over time will eclipse the cost of financing a new car. This is the consensus in the industry. Let’s take the example of the new car at $38,000 for six years at a 4.25% interest rate. This comes to a monthly payment of $598.86 which comes to $43,118 in total cost. So this means that the payment for the lease will be higher than $599 based on the math that we just presented. In truth, the consumer doesn’t think of it that way because he or she is just getting the next new car with all the bells and whistles and is accustomed to the normal payment. The hidden factor and the most economical route is paying off a car beyond our six-year comparison is that when you can own a car outright, every month beyond the six years with relative maintenance, you avoid a monthly payment. Hence, you can put that prior monthly payment to good use to pay debts, invest or save for the next automobile. Unequivocally, the dealer wants you to lease over buying just by following the same math that we did. They make new products that have higher retail value and they charge more for it. Hence, if you keep leasing they have more money in their pockets. It’s no different than having your phone plan in your budget: you make the monthly payments and in time you are eligible for the upgrade; and the cycle keeps repeating itself. What is the Right Road to Take? This is one of those cases where an apples-to-apples comparison can’t be made there aren’t one-to-one relationships to measure against. Let’s Do the Recap and Throw in Some Tips #1 If you buy a car, six years of payments is a good recommendation limit. The longer the term, the more depreciation occurs and owners can get upside down on their value. At some point, especially early in the loan-term, consider If the car is stolen, or totaled, there is a chance that the insured, traded-in or resale value may be less than what the car is worth. #2 This is why some people opt for gap insurance. This will pay the difference between what is owed on the car and what it is actually worth. Suppose you purchase a new Tesla for $70,000, and $65,000 is borrowed. Then unfortunately, it is stolen six months later and the car is worth 50,000.This would leave the owner $15,000 short and this is where gap coverage kicks in. #3 The third option is to buy a used car as it loses value immensely as soon as it’s driven off the lot. Here’s some stats taken from Nerdwallet: the value of a new vehicle drops 20% - 30% in the first year of ownership and after five years the value goes down up to 60%. For example, a five-year old vehicle that sold for $30,000 will be worth $12,000. #4 If you can wait to buy a used or a new car that may be the best option. Researchers at UBS found that used-car prices may have shot up by 8.2% to 9.3% in April (2021). UBS estimates that's the largest monthly price increase in 68 years of tracking used cars. #5 If you're experiencing a budget grind, selling your car can be to your advantage: you could make some nice gains and then downgrade your next car to reduce your cost burden on the budget. If you have access to other transportation and can live without a car for the next few quarters then this is an even greater opportunity to save money for the short term. #bloggingtips#WixBlog Episode Link:

It is Better to Lease or Buy a Car