If you graduated this past May and don’t have a car, chances are that you’re probably looking for one to make your daily commute. Here, you could either purchase a new car or a pre-owned car. Most of the time it makes sense to purchase a pre-owned car as a college grad may not have a lot of money to throw away on a new car. It can be tricky to find your dream car—colors, trims and other accouterments may be limited. Most likely you’ll be stuck with this car for years, so you better love it. There is a third option, however: leasing.
In the past, leasing has traditionally been used by more well-off individuals to drive luxury cars at affordable prices. However, the leasing of traditionally affordable cars is on the rise. In fact, according to the New York Times, leasing has become increasingly popular for mass market brands like Chevrolet, Mini, and Ford. In 2012, 10 percent of Chevy customers opted to lease; this number has almost doubled as of 2015. The increase in leases can be attributed to a refocusing of leasing on monthly payments, as well as the desire to have the latest technology in a car—for example Apple’s CarPlay and lane changing cameras.
You may be asking yourself, “Isn’t leasing more expensive than purchasing a car outright?” You wouldn’t be entirely wrong in stating that it is more expensive to lease a car than to buy it. On paper, leasing is more expensive. Nonetheless, it may make more sense financially to opt to lease than to purchase a pre-owned vehicle.
To best understand why leasing is more expensive than outright buying a car let’s think of this in terms of economics. When you lease a car you typically agree to a three-year contract, with 30,000 to 36,000 miles over the lifetime of the contract. If you go above the agreed upon limit you’ll pay a fee per mile—usually around 25 cents. Like purchasing a car, there is money due at signing and in monthly installments. What’s usually not publicized in the promotion you may see are the additional fees, such as, dealer fees, DMV fees, and taxes on the car. Depending on the car, this could be an additional $1,200.
During a leasing agreement, you can pretty much divide up the total costs into the “due at signing” costs and the monthly installments. If you see a low amount due at signing costs, then you’re most likely paying a lot on a monthly basis. Instead of focusing on the monthly installments of the lump sum you have to pay initially, it may be better to look at the total cost of the car over three years. The amount you pay during a lease will essentially be equivalent to the amount the car will depreciate over the course of three years. The car then has a residual value at which you can purchase the car after the lease. This is about 55% of the MSRP of the car. Therefore, if a car has an MSRP of $20,000, it’s buyout price would be $11,000.
When you add up total costs, with the estimated residual value, you’ll get the estimated cost of the car if you were to buy it after the lease. So why would you opt to lease a car if you planned to buy it? There are two reasons why you might want to lease a car. First, there is uncertainty if you’ll need the car after three years. This may be especially true of college graduates who are now more likely to change their job. If you moved across the U.S. and weren’t able to have a car at your new place the last thing you would want to do is pay for an automobile you’re not using. In a car lease, the difference you’d pay between buying and leasing is the premium that you pay for the option to forfeit ownership of the vehicle at the end of the contract. If you can lower this premium down, then the total cost plus the residual value will resemble something more like buying price of the car. Your goal should be to mitigate the premium.
Second, money has less value tomorrow than it does today. Therefore, by leasing a car you may be elongating the time in which you’re paying it off. By the end of a three-year contract, you’ll have paid off about half the value of the car. Furthermore, if while you were making payments you also saved up some cash on the side you may have the capital to purchase the car at the end of the contract while only taking out a small loan.
If you wanted to purchase the car at the end of the lease you’ll essentially incur any extra devaluations to the car. This is because the dealer typically will sell the car to you for its residual value. However, this value is negotiable, as it is the cheapest option for the dealership. It’s more economical to have the certainty that an individual will purchase a car at a lower price, rather than the costs that would be incurred if that car sat for a period of time and depreciated on the lot. In addition, lot space is scarce, and the push to get newer models to the dealer makes space ever scarcer.
Therefore at the end of the lease—usually 60 days before the end of the contract—the dealer will contact you about either continuing the lease to another car or purchasing the car. If you started to lease a car now, with the rise in leases, dealers should be incentivized to sell you the car at the end of the contract. As more lease contracts come to a close, dealers will want to mitigate a number of pre-owned cars on their lot. Furthermore, if there are more pre-owned cars on the market, this should help your negotiating powers to lower the price if you opt to purchase the car.
Leasing is no longer relegated to the wealthy, as typically people may look to lease cars as a means of accommodating for uncertainty in their lives. By mitigating the leasing premium and staying focused on the total costs instead of monthly payments, you may be able to lease a car at a price close to the value that you could buy it at.
“Automotive Lease Volume Reaches Record High in 2016, According to New Edmunds Report.” Accessed June 7, 2017. https://www.edmunds.com/about/press/automotive-lease-volume-reaches-record-high-in-2016-according-to-new-edmunds-report.html.
Driscoll, Emily. “Should College Students Lease or Buy a Car?” Text. Article. FOX Business, April 29, 2013. http://www.foxbusiness.com/features/2013/04/29/should-college-students-lease-or-buy-car.html.
“How to Lease a Car | Edmunds.” Accessed June 7, 2017. https://www.edmunds.com/car-leasing/quick-guide-to-leasing-a-new-car.html.
“Record Highs of Americans Leasing Vehicles.” Accessed June 7, 2017. http://www.cnbc.com/2015/06/01/record-highs-of-americans-leasing-vehicles.html.
“Report: More New Cars Leased than Ever.” Accessed June 7, 2017. https://www.usatoday.com/story/money/cars/2016/03/03/report-more-new-cars-leased-than-ever/81286732/.