Should You Buy a Car or Lease It?

Buying a new car is one of the largest financial transactions most consumers enter into, exceeded only by the purchase of a home. Traditionally, new cars have been purchased with cash or by a loan.

But the 1980s saw a rise in auto leasing, and it is predicted that by 1995 as many as half of all new cars will be acquired under some kind of a lease agreement. While leases are not difficult to understand by themselves, the choice between a lease and a loan can be quite complex.

Generally, a loan has a lower overall cost to the consumer over a period of three to four years, compared to a lease of the same duration. The lowest-cost approach to owning a car definitely is to hold it more than four years and virtually drive it into the ground. By the time a car has more than 100,000 miles on the odometer, it is considered fully depreciated.

Most motorists don’t like this approach, though, preferring to trade in a car before its value has declined to $1,000 or less. So, the average period of ownership for a new car is considerably short of 100,000 miles.

Consumers trying to decide between a lease or a loan have not had an abundance of information to help make their selection, but a small and easy-to-understand book has recently been published that helps sort out the issues. “Lease Your Car for Less,” by Richard L. Kaye, takes a consumer through the leasing jungle and offers an easy work sheet for comparing leasing and loan costs. It is available at most bookstores.

Since, over its lifetime, a lease generally costs more than a loan, what advantages does it offer? Under a lease, a motorist does not put up a large initial down payment, monthly payments are typically lower, and there is no risk that a car will depreciate in value unexpectedly because of defects revealed by the manufacturer.

These factors mean that for the same monthly payments and cash outlay, a motorist can afford a larger or more luxurious car. Leasing allows a trade up in status or at least the public image of that status, a strong motivation in our consumer culture and one that seems to grow more powerful every year.

There are four important elements that determine the cost of a lease: the vehicle purchase price, the estimated residual value at the end of the lease, the lease rate or fee, and extraordinary fees, taxes and service charges.

Kaye’s first bit of advice, if you intend to lease, is to negotiate for the lowest possible purchase price, the way you would if you planned on getting a bank loan. The important point is not to tell the dealer that you intend to lease until after you have agreed on a price. (This may be a bit difficult in practice, since dealerships almost always insist on knowing how a car is to be financed before a final agreement on price.)

Next, you will need to examine the lease rate, whether it is computed by the cap-cost method or the constant-yield method. The leasing company often will not disclose the rate, but in his book, Kaye has an easy formula for computing that rate.

The residual value is just as important as the purchase price of the vehicle, and leasing companies differ in these terms. And extraordinary fees can be treacherous, since they include charges for excess mileage at the end of the lease and penalties for poor condition.

One important piece of advice is to limit the lease to the duration of the original warranty on the car, which should also protect you from unexpected repairs. And if the car turns out to be a well-known lemon and depreciates in value unexpectedly, you can walk away unscathed.