The car lease – the sucker punch to the American middle class… The average American monthly lease payment is $412/month with over 30% of cars on the road today being leased. This is my longest blog to date, so buckle up and enjoy the ride…
According to edmunds.com a new car will depreciate by 11% the moment you drive off the lot and 20% in the first year. By year 2 you will have seen 30% of the value gone with 50% of the value gone by the end of year 4. Simply put – OUCH!
In looking at leasing you are presented with the opportunity to only pay for the portion of the car you use (the depreciation amount), meaning you’d pay $15,000 to drive a $30,000 car for 4 years at 50% average depreciation. You won’t have to worry about selling your used car on Craigslist or what a trade-in might be worth down the road, you’ll just bring your leased car back to your dealership and a friendly salesman will get you back into a brand new chariot with no hassle at all – sounds good?
Breaking Down the Debacle:
When leasing a $30,000 car (your capital cost) with a 50% residual value of $15,000 at the end of a 4 year lease you’re looking at ($30,000 – $15,000) / 48 = $312.50 per month as your “base payment” – which is the cost of the depreciation and what you’ll pay in monthly payments, right?
Put on the brakes there cowboy. Remember, this leasing outfit has $30,000 tied up for 4 years and they expect a return on that FULL amount they have invested over that time. This is where your friendly salesman will present the “Lease Factor” to you, and it will be expressed as a harmless little number like 0.00166. He may even present this as a 1.6% APR, which is what it looks like, but to figure your APR the lease factor must be multiplied by 2,400. That means it’s closer to 4% APR instead…
To figure your monthly “rent charge” with this lease factor you’ll add the capital cost (price of car) to the residual cost (what it will be worth at the end of the lease) and multiply by the lease factor: ($30,000 +$15,000) x 0.00166 = $74.70. This will be added to our monthly payment above to equal $387.20/month. Now we’re picking up speed!
But I’ll be damned, now the tax man wants to ride along, so we have to factor him in too. That’s 7% in Tennessee on a car lease, so…. $387.20 x 1.07 = let’s call it a total payment of $414/month among friends – right on average…
Now the car dealer wants some money in exchange for processing the lease, and he wants it now. This will come in the form of acquisition fees, document fees, and disposition fees and will probably equal around $1,250 by the time it’s all said and done.
Don’t forget, you’ll only be allowed to drive this little jewel around 12,000 miles per year. If you go over you’ll pay around 15 cents/mile – and you will, because it’s so fun to drive, right??
So… Let’s say $1,250 in fees + $1,500 in mileage overages + 48 payments @ $414 and you’ll be on the hook for $22,622 across the life of the 4 year lease for a car worth $30,000. That ends up being a “real cost” of around $471/month all-in and an auto-draft of $414/month from your checkbook to make it happen.
Now, at this point you’ll be a little trembly and your throat may feel a little tight, but your salesman has a big smile on his face as he compares what it would cost you to BUY the car over 4 years instead.
Let’s say you land a 4.5% interest rate for 48 months on this $30,000 car (the current bankrate.com average car loan rate). Your payments would be a whopping $684/month! This lease is a STEAL at only $414/month – Come on, only a fool would think of BUYING a car! All the smart folks are leasing these days, and don’t you see why?
Truth be told you’d have to take the monthly difference in the “real cost” of the lease ($471/month) and buying ($684/month) and invest that $213/month to earn 7.5% per year across 4 years to equal that $15,000 in car equity you would own if you were buying the car that disappears when leasing the car. While I would never finance a car, given these two options I would steer clear of the lease – wouldn’t you? Never mind – I know that $213/month is going to Ethiopian dark roasted espresso + 2% milk foam. Am I right?
Have you stopped to think what happens at the end of the lease? When you turn in the keys, how will you get home? You end the 4 year lease with NOTHING! At least with the car payments, after you finish paying them you’ll be left with a 4 year old car worth $15,000. With leasing you will ALWAYS have a payment for as long as you have a car…
As a Man on the Move I drive a Jeep made in 1999 meaning it’s fast approaching its 20th birthday, or 5 “cycles” of my 4 year lease/buy scenario above. My Jeep still runs great and I have the skills and tools necessary to repair it as needed along with the wherewithal to use quality fuels and fluids to keep it running well and trouble-free. When my “Check Engine” light comes on I run the codes and swap out the O2 sensor for 80 bucks – what did your last “Check Engine” light cost you? I can change my own oil, coolant, and transmission fluid, and easily accomplish repairs like new brakes and rotors or new shock absorbers as needed. I currently have a small exhaust leak I need to find, but I’m not too worried as it should be a simple fix…
Let’s say you and I walked into a dealership in 1999, looked at that $30,000 car, but chose different paths – I chose to finance/purchase and you chose to lease. Roughly 20 years later you’re nearing the end of cycle #5 with your leases while I only rode out cycle #1 (4 years of car payments) and sat out the last 16 years as I was happy to continue driving my car – faded paint and all. (and no, I am not recommending financing a car…)
Let’s also say that in those 16 additional years I took your “real cost payments” of $471/month and invested that amount instead of throwing it at car leases, earning an average of 10% annually in a basic index fund. After 16 years you would still not own a car as you face yet another lease coming due and you need some form of transportation to replace the car you’re about to go turn in. Do you need a ride to work or do you want to borrow my bicycle pump?
Meanwhile, by way of frugality, I would be sitting on well over $200,000 in investments that I earned during the 16 years you were leasing cars 2, 3, 4, and 5, and I was investing the same amount of money you were using to lease. Plus, to add insult to injury, I’d still have a 20 year old car that’s running well and worth around $2,000. You? Nice shoes…
A true Man on the Move – you’d get on board with this guy, right? © Wenner Media / awaiting permission
Obviously, since you’ve never been seen in a car older than 4 years old, it will appear to your friends and neighbors as if you are the one with all the money, but once we look under the hood I think we may see a completely different scenario.
Remember when I called this the “sucker punch to the middle class” ? It is a brutal shot to the mid-section that comes undetected while most people are looking high and thinking they are the ones about to score the knock-out blow in terms of societal wins.
Please… Don’t tell me about the tax advantages of your lease! No, no, and no. See the mortgage interest deduction ploy for a similar fallacy. What you save in taxes will never make up for what you lose in equity. With both leasing AND buying a car, the amount that can be deducted from your taxes is directly related to the percentage of car usage that is business related, not 100% of the payment. Leasing offers little significant tax advantage over ownership as you can still depreciate a purchased car, plus claim deductions on its sales tax, mileage use, and operating costs.
Can We Profit?
Can we get on the other side of this lease trade – the profit side? There is a firm in England called http://www.buy2letcars.com that will take your capital and turn it into funding for car leases with an expected return of 7% / year on 10,000 pounds invested. You could also look into popular peer-to-peer lending sites like Prosper or Lending Club where a mid-grade loan of $15,000 for 10 years would earn you a little over 10% / year. Personally, I’m not going to go down that road of investing in these ideas as the risk/reward ratio in the form of default risk is a bit too high for me, but the opportunities do exist should you choose. Tread carefully…
If you need to finance or lease a car then the reality of the situation is you cannot afford the car you are wanting to drive. I know that goes against any grain of “normal” these days when a car payment is such a “normal” part of life, but financing a fast-depreciating asset is a horrible idea and counter to any wealth-building strategy in personal finance. Leasing is even worse.
Try as you may, you can’t beat math… from Edmunds.com
Take a look at these depreciation curves, do some math, and consider saving up some cash. Let’s let Mr. Leaser take the big hit on the depreciation, and pick up his 4 year old car for $15,000 and drive it for 6 years, selling it for $6,000. Instead of a lease with a $15,000 hit across 4 years ($3,750/yr) ending with $0 equity we’d see a $9,000 hit in depreciation across 6 years ($1,500/yr) ending with $6,000 in equity – that’s 60% LESS depreciation cost per year. Thinking like this will put you in the fast lane toward financial independence, wouldn’t you agree?
Next blog we’re going to talk career change, but we will re-visit some other common financial fallacies down the road… See you soon!