Well, yet another week and yet another Finance Friday video.
So as I said last week the car is the most expensive purchase most people make that goes
down in value.
Now with that in mind wouldn't it make sense that you wouldn't want to make a big purchase
on something that is almost guaranteed to go down in value?
What if you didn't actually buy the car at all?
Would that be better for your financial Foundation?
That's what we're going to be talking about today as you can see by the title of the video
today we're going to be talking about leasing versus buying a car.
Hey everyone, Daniel here and welcome to Next Level Life a channel where you can learn about
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So I thought talking about this would be a good follow-up to last week's video on the
20, 4, 10 rule.
So today I'm going to be talking about what leasing a car is and how it differs from buying
a car, some of the benefits and downsides of both Leasing and buying.
I’ll show you how a car lease payment is calculated and then doing a bit of a mathematical
comparison between the two options where I will also tell you how Dave Ramsey says that
car leases charge you an effective interest rate of about 14% or 15%.
This is going to be a bit of a longer video, so let's get started.
So first let's define the difference between Leasing and buying a car.
The best way that I can explain it is to say that leasing a car is basically just renting
the car.
Similar to how you might decide to rent an apartment instead of buying a house.
When you lease a car the lessor or the person holding the lease rents the car to the lessee,
or you, for a specified period of time in return for periodic payments.
Now that sounds in many ways very similar to what happens when you sign a car loan right?
You got the car in return for making regular payments to the loaner.
The difference, of course, is that once you finish paying off the car loan you own it.
However, when you lease a car and the lease term ends you trade the car in and assuming
you sign another lease you get a new one.
This means that at no point in time do you actually own the car.
It is never an asset for you.
Whereas if you were to sign a car loan and make payments the car would be an asset to
you after the final payment is made.
Now, of course, you can decide to purchase the car that you least out right at the end
of the lease, that is an option, but not a whole lot of people do that and we'll get
to why that is later in the video.
But first, let's talk about some of the benefits of leasing a vehicle.
The first benefit that people often point to is that under most circumstances unless
you make a really big down payment when you buy a car the monthly payment on a lease is
generally going to be lower than the monthly payment on a car loan.
And again I will show you exactly why that is when I get to the comparative example but
for now, let's just go through the benefits.
The second benefit that people often pointers that there's no need to worry about selling
your car at the end of the lease term because when the lease term ends as I said is simply
drop the car off at the dealership and either sign a new lease or move on to some other
car buying strategy.
The third benefit to leasing that many people point to is that the car often times remains
covered under a warranty because the lease terms generally don't last more than say 3
or 4 years and sometimes they're even shorter.
And since the warranty on most cars is roughly the same as the lease length or at least the
average lease length you often times have a more predictable total cost of car ownership.
And some leases may even include basic maintenance so if that's the case you're only cost would
be insurance and fuel.
The fourth benefit that many people going to is the small down payment that is required
for a lease.
And you could argue whether or not that's really a benefit but we'll get to that later
in the video.
But for those consumers who don't have a lot of money saved up for a downpayment, it often
seems like a good benefit.
And obviously when you're leasing cars every few years you always have access to at least
nearly the latest technology if not the latest technology goes your car is new.
And for many, this is a huge benefit.
The last benefit that people often point to when it comes to leasing versus buying a car
is the potential tax savings that you may experience.
Although you'll definitely want to check with a tax professional to find out how leased
vehicles are taxed in your area because it does vary from place to place so that may
be a benefit and may not be a benefit depending on your situation.
The downsides to leasing a car are of course the rules and restrictions that seem to pop
up all over the place.
Depending on your lease you may have mileage restrictions, excess wear-and-tear fees, ride-sharing
restrictions, the need to have excellent credit, and possibly even the need to purchase gap
insurance.
Typically you will have mileage restrictions on leases between 9,000 and 15,000 miles per
year and if you go over that you get charged a pretty hefty excess mileage fee which can
range from $0.20 a mile to a $0.25 a mile or maybe, even more, depending on what it
says in your lease.
Now of course I'm told from people who have leased cars that they don't generally check
the amount of Miles you've driven each year but rather if it's say a 3-year lease and
you have 15,000 miles per year that you're allowed to drive they will check it at the
end of the lease and see if you went over 45,000 miles and if you did they will charge
you for the extra miles at that point.
I have not ever released a car so I have to go with what I've heard from people who have
and that's what they've said.
As far as the excess wear-and-tear fees go I'm told that some wear and tear is to be
expected you won't be charged for every minute thing but you are expected to return the car
in nearly its original condition and any customization that you have put on the car needs to be easily
removable.
And in some places you'll also have to be able to show that all recommended Services
were performed on the car at the proper times so I imagine there is quite a bit more paperwork
with this route as opposed to buying a car, which may matter for some but for some others
it may be worth it.
I've also been told that with very few exceptions you need to have top-notch credit scores to
be able to lease a car and leasing companies almost across the board require you to purchase
gap insurance.
And of course the last downsides to leasing a car is that some leases will have early
trade-in fees or penalties and you never hold any equity in the vehicle when you return
it at the end of the lease contract you will have nothing to use as a down payment on your
next vehicle unless you were diligent and saved up during the time that you had the
lease.
And obviously, when you're buying a car the benefits and downsides are flipped.
When you buy a car you don't have any monthly payments after the loan is paid off you don't
have mileage restrictions or any customization or excess wear-and-tear fees and your credit
does not have to be excellent although it would certainly help when it comes to interest
rates on a loan.
However it is generally more expensive in the short-term month-to-month then leasing
is, some dealers will try and talk you into a long-term loan since it makes the monthly
payment look smaller but it usually carries a higher interest rates and of course keeps
you in debt longer which is generally not a good thing, and you may need a pretty hefty
down payment depending on your situation.
So how do you calculate a monthly lease payment?
This is one thing that I wasn't going to do initially in this video but decided that I
should do it because I couldn't find too much information about this in other videos on
YouTube.
First, you'll need a few things.
You'll need the MSRP of the vehicle also known as the sticker price of the vehicle.
Next, you'll need the money factor which is also sometimes called the lease factor or
even a lease fee and you'll usually need to call the dealership that you're looking to
lease the car from in order to get this.
They will likely ask you what brand make and model you're considering leasing so be sure
to have that information ready when you call.
Third, you'll need the term or length of the lease most sites that I researched recommend
leasing for no more than 36 months but there are some specials for 39 months.
But the point is you need to know how long your lease term is going to be.
Once you have that you'll want to find the residual value of the car by asking the dealer
what the residual percentage is for the specific car that you're considering while you're on
the phone with them.
The residual percentage varies of course between dealers in cars but it's usually somewhere
in the neighborhood of 45% to 60% for a 36-month lease.
You also need to find out if there are any fees associated with the lease.
Common fees include registration fees, acquisition fees, and sometimes down payment tax but there
may be others.
And the last thing you'll need is any rebates that are available to you if you have any.
Once you have all that information here's how you calculate your monthly lease payment.
For this example let's say that John is going to lease a car with an MSRP of $25,000.
To keep the math simple will say the residual percentage is 50% and the money factor or
the least Factor will be 0.00125.
He's Leasing and will not make any down payments on the car and he does not have any rebates,
but he does have $1,200 in various fees and has a lease term of 36 months.
Once you have all that information here's how you calculate your monthly lease payment.
The first step is to take your vehicle's MSRP and multiply it by whatever the residual value
is that you are given.
In John's case, that means he takes $25,000 * 50%.
This gives him a residual value of $12,500 for his leased car.
We're going to assume for the sake of this example that he did not negotiate the actual
sale price on a car and instead just purchased it for the sticker price or MSRP.
Therefore Step 2 is to take the sale price and add in any of the fees that you have to
pay in order to get what the car manufacturers called the gross capitalized cost.
In this case, since he didn't negotiate, he paid the MSRP of $25,000 and had $1,200 in
fees.
Therefore his gross capitalized costs are $26,200.
Step 3 is to take any down payment, trade-in equity, or rebates that you might have an
add them together in order to get what they call your capitalized cost reduction.
In John's example, he didn't make any down payments and he didn't have any trade-in Equity
or rebates so his capitalized cost reduction is just going to be zero.
Step four is to take the gross capitalized cost that you figured out in Step 2 and subtract
the capitalized cost reduction you just figured out in step three in order to get your adjusted
capitalized cost.
again in John's case, he didn't have anything in step three so is adjusted capitalized costs
are the exact same as gross capitalized costs cost of $26,200.
Step 5 is to take the adjusted capitalized cost you figure it out and step 4 and subtract
the residual value that you figured out and step one in order to get what they call you
or depreciation amount.
In John's case, his adjusted capitalized costs were $26,200 and his residual value was $12,500.
So punching those into the calculator you find that his depreciation amount for the
car lease will be $13,700.
This number is very important because it's what your base monthly lease payment is going
to be calculated with.
And that's what we do in Step 6 you take the depreciation amount you figured out and step
five and divide it by however many months you are leasing goes for.
In John's case, he had a 36-month lease so he takes $13,700 and divides it by 36 which
gives him a base monthly payment of about $380 a month.
But don't get excited we're not quite done figuring out your actual monthly payment yet
there still a few more steps.
In Step 7 you take the adjusted capitalized cost that you figured out and step for and
add the residual value that you figured out in Step 1 and then you multiply that number
by the money factor.
So in John's case, he had an adjusted capitalized cost of $26,200 and a residual value of $12,500.
So we add those and that gives us $38,700.
we then take that $38,700 and multiply it by the money factor of 0.00125 which gives
us a little over $48 a month.
This number is what the leasing companies called the rent charge.
Step eight is where you at that rent charge to the base payment that you calculated in
Step six to get your pre-tax lease payment.
In John's case, this means he takes the $380.56 that he calculated In Step 6 and adds the
$48.38 from Step 7 to get a pre-tax monthly lease payment of $428.94.
Now if you're lucky enough to live in a state that doesn't charge sales tax you're done
calculating your lease payment.
However, if you're like most of us that live in a place that does charge sales tax then
you need to multiply that pre-tax monthly lease payment by the local sales tax rate
where you live to get your total monthly lease payment.
Let’s say John lives in Santa Monica California just for the sake of this example they have
a sales tax of about nine and a half percent.
Meaning that he would have to take that pre-tax monthly lease payment of $428.94 and multiply
it by 1.095 to get his monthly total monthly lease payment of $469.69.
So that's how you calculate a lease payment.
Now I know that many of my viewers also watch Dave Ramsey and so you’ve probably heard
him say that leasing a vehicle is the most expensive way to own a car.
He says that on average the effective interest rate on car leases are about 14%-15% which
is about as high as the average interest on credit cards.
So this is kind of a big deal.
But one thing that I haven’t heard him talk about before is how the people calculating
that effective interest rate arrives at 14% or 15% because you certainly don’t see anything
on the lease contract that says you’re paying 15% interest on this lease.
You see what the money factor is but that’s about it.
Well here’s how you calculate it.
When John was paying for that lease on his $25,000 MSRP car, the base monthly payments
weren’t actually being calculated based off of $25,000 like they would be on a normal
car loan were they?
No, they were being calculated based off of the difference between the cost of buying
the car (after things like registration fees were taking into account) and what the residual
value of the car will be at the end of the lease term, which is obviously estimated by
the leasing company prior to you signing the lease.
In the example with John, the difference between those two numbers was $13,700.
So let’s say that for example instead of leasing a car, he decided to buy a car for
the same $13,700 that his base monthly lease payments were being calculated with.
And let’s also say that the $13,700 car loan that he signed when he bought the car
was for 36 months and his monthly payments were just under $470, just like they ended
up being for his lease.
If you punch those numbers into a loan calculator and ask it to find you the interest rate on
the loan, you’ll see that it comes out to be about 14.2%.
And just for grins and giggles do you want to know how much you would be paying a month
if you bought a $25,000 car instead of leasing it?
Well assuming we go with the averages, the average interest rate on a new car loan according
to Experian is a little under 4.5%, so I’ll use that for the interest rate and I’ll
say it's a 60-month car loan.
The monthly payment?...
$466.08.
So not all that much different than the lease, except for the fact that you may have some
resale value at the end of the car’s run that you can then use for a downpayment on
the next one.
So as you can probably tell, I personally am in favor of buying a car as opposed to
leasing it, but that doesn’t mean that my opinion is objectively and universally the
correct one.
For some people, it may be worth taking on that higher effective interest rate in order
to always be driving with the latest technology and not having to go through the hassle of
selling the car at the end of its run.
And that’s perfectly fine, my goal with this channel is not to tell you what to do
with your money.
My goal is just to make sure you are aware of what options are out there and do my best
to clear up any mysteries in the realm of personal finance.
But that'll do it for me today once again if you enjoyed this video be sure to subscribe
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