Leasing Vs. Financing Guide

[doubleapex]

Leasing v. Financing

I wanted to start a thread that will help people understand leasing and financing. This is a long thread, but it kind of needs to be as there’s a lot to cover. I’m going to talk about misconceptions, define what a lease is, show some examples of leasing versus financing and then list a few pros and cons for both.

First of all let’s talk about some misconceptions in leasing and financing.

Just because you’re financing a car, it doesn’t mean you own it. You do not own a car until you’ve made all the payments. If at month 59 during a 60 month term you decide to not make that last payment, the lender will repossess the car, because the bank still owns it! Unless you pay cash for a car, or make every payment, you don’t own it!

“I don’t lease, I only buy.” A lease is actually another way to purchase a car. The reason people say this is that they think one will always pay more for a car if they buy it out at lease end versus having financed the car for 60 months. Although this can be the case, many times (especially with BMW’s) it can actually be less expensive to lease a car and then buy it, versus financing it for 60 months. Examples to come…

Here’s a contradictory statement some people make: “I want to pay cash for a car because I don’t want a car payment!” Well, if you think about it—they just made a payment. Granted it was only one—but it sure was a big one! So what they’ve done is chosen to make one huge payment versus a bunch of smaller ones. Only bus and bicycle riders can escape a car payment(s).

Dealerships rip people off when they lease cars. True, in the past, leasing had the stigma of dishonesty…and actually they were. This was because the leases were called, “open ended leases.” This had to do with the value of the car at the end of the term and the dishonest part was, dealerships were overvaluing the payoff of the car and people were paying a lot more for their cars than they were worth. Times have changed and now we only sell “closed in leases.” This type of lease locks in the residual value so that one’s payoff will be printed on the contract and cannot be changed by anyone.

“I drive too many miles to lease.” You can still benefit from leasing if you can keep your mileage under 100,000 in any term (at least that’s the way it is for BMW).

“My client advisor said that if I go over miles, it won’t be a problem and they won’t charge me for the excess.” WRONG! If you go over your contracted mileage you’ve depreciated the car. In other words, you’ve made it less valuable and you haven’t paid the lender for it. In some form or fashion, you WILL be paying for those miles, so it’s very important that you’re accurate with your estimates.

“I want to be able to modify my car…so I can’t lease.” Although modification can void warranties, it doesn’t mean you can’t do it. However, a car does need to be in ‘stock condition” IF it’s turned back in. All you need to do is keep the stock parts around!

At any time during a lease, you can buy your car out by sending the bank a check for your payoff. You can trade your car into a dealership and they will send the check on your behalf. You can sell your car in the private party marketplace. You can have someone assume the lease you are currently contracted in.

Whether you lease or finance a car, unless you’ve put a lot of money down, the chances that you will have negative equity are good! Cars simply depreciate faster than we pay them down. This simply means, you’re going to owe more than the car is worth. This is a great reason to consider investing as little as possible into a car—because you’ll rarely break even let alone make money.



How does a lease work?

A lease is made up of three parts: Depreciation, Interest and Tax. (interestingly enough, a finance payment is also made up of those three parts!)

Depreciation is determined by the residual value of the vehicle. For instance, if a bank has placed the value of a 530i at 60 percent after 36 months, you’ll be paying down 40 percent of the cars MSRP (not the selling price). In other words, the bank is estimating that a 2007 BMW 530i will retain 60 percent of it’s value.

The interest you pay is also known as the money factor (and in the finance world, it’s a.p.r.). A money factor will look something like this, .00150. To find out what interest rate that translates to, multiply the money factor by 2400. So .00150 x 2400 is like 3.6 percent.

The tax you will pay is based on your usage of the vehicle. This is one of the reasons your lease payment is lower than a purchase payment. On a purchase, your payment includes tax on the entire cost of the car. The tax you will pay on your lease is dependant upon where you will be registering the car—not where you are purchasing it from.


Now let’s look at some examples of leasing versus purchasing.

We’re going to compare two cars, a BMW 530i and a BMW 335i sedan. I’m going to use actual BMW rates and residuals from the month of November, 2006.

First, the 530i.

MSRP $53,070
Selling price $51,470

Lease Terms:
Payment 669.66 (includes 7.75% sales tax rate)
Drive offs $1,966
Money factor .00090 (2.16% a.p.r.)
Term 36 months
15,000 miles per year
60 percent residual = $31,842 at lease end

Finance Terms:
Payment $1,071.69
Down payment $2,000
Rate 6.99 (700 plus fico)
Term 60 months

Now it becomes simple math.

First let’s look at the overall cost of leasing the car for 36 months and then buying it at lease end. (in the first calculation we use 35 months because our first months payment comes out of the $1,966 drive offs).

35 months x $669.66 = $23,438.10 in payments

$23,438.10 + $1,966 = $25,404.10 in 36 months

So now we’ve driven the car for three years and spent just over 25k and we can either decide to buy the car or go get something else. Now, another common misconception is, if you decide to go buy something else, you’ve lost everything you’ve spent. But this is not true. You’ve driven the car for three years and here’s what you have saved versus financing!!!….

In our 60 month purchase scenario, let’s see how much we’ve spent in the first 3 years of our loan. It’s pretty simple math…

36 x $1,071.69 = $38,580.84

$38,580.84 + $2,000 down payment = $40,580.84 (cost for the first three years)

So during our first three years of the purchase, we’ve spent over 40k versus the 25k we’ve spent in the lease. In both scenarios, we still DO NOT OWN THE CAR yet!!! However, in our lease scenario, we have saved $15,000 in the first three years. We have this money in the bank and available. In our purchase scenario, if we want that money, we’re going to have to HOPE we can get it back by selling the car on the open market.

This brings up another benefit to the lease. In the lease, all the risk (in regards to the vehicles value) is on the bank! Our payoff on the 530i at lease end is just under 32k. If we’re considering purchasing the car, we can now compare the value of the car in the marketplace and determine if it’s a wise decision. If the car is worth more than the payoff, then we get to buy the car for under market value. If on the other hand, it’s worth less than our payoff, then it probably won’t make sense to purchase it. But again, if you walk away, you’ve got that 15k in the bank and driven a great car for 3 years, all while under the factory warranty.

Now let’s say that you’ve decided to purchase this 530i at the end of the lease. Let’s see if you’ve made a good decision.

We’ll take our total of payments and add them to our residual value, along with some tax and interest. In this final calculation we’re going to put down $5,000 of the $15,000 we’ve saved. So in essence we’re looking at financing our remaining balance, minus $5,000 over 24 months. (36 month lease plus 24 month finance = 60 month term)

$25,404.10 in payments and drive offs + $31,842 in residual value = $57,246.10

$57, 246.10 + 2400 in taxes (7.75%) + 2300 in interest (24 months at 6.99) = $61,946.10

So our total cost to lease and then buy is $61,946.10

Now we need to compare that number to what it would have cost us to finance the car from the very beginning.

We’ll take our term of 60 months x our payment of $1071.69. the total of our payments are $64,301.40

But don’t forget to add in the original $2,000 we put down! This makes our total cost to finance the car for 60 months, $66,301.40.

In this scenario, the lease makes the most sense. During the first 3 years the lease saves you $15,000. If you decide to purchase this car, in the end it saves you $4,355.


Now let’s look at the 2006 335i sedan

MSRP $35,220
Selling Price $35,220

Lease Terms:
Payment 678.33 (includes 7.75% sales tax rate)
Drive offs $1,718.52
Money factor .00190 (4.56% a.p.r.)
Term 36 months
15,000 miles per year
61 percent residual = $27,584.20 at lease end

Finance Terms:
Payment $937.17
Down payment $2,000
Rate 6.99 (700 plus fico)
Term 60 months

Since we’ve already talked about all the numbers and what they mean, I’m just going to list out all the calculations for you.

Lease calculations

35 x 678.33 = $23,741.55

$23,741.55 + $1,718.52 = $25,460.07 (total cost for lease over 36 months)

$25,460.07 + $27,584.20 (residual value) = $53,044.27

$53,044.27 + $2,000 (7.775% sales tax) + $2,100 (6.99% a.p.r) = $57,144.27

So our total cost to lease then buy is $57,144.27


Purchase calculations

During the first three years of our 60 month purchase we have spent,

36 x $937.17 = $33,018.12 + $2,000 down = $35,018.12

Total purchase cost equals

60 months x 937.17 = $56,230.20 + $2,000 down = $58,230.20


So our conclusion then is, during the first three years of either scenario, the lease saves us $9,600. In either scenario, in the end, if we buy the car at the end of the lease we saved just over a thousand dollars. In the end it’s almost a wash. Even still, wouldn’t the lease make the most sense then? If it costs the same in the end, why not at least give yourself the option to walk away at the end of the lease with almost $10,000 in your pocket…

The major reason why these two scenarios showed the lease to be better overall is due to the interest rate. Auto loan rates are high right now. I was using a rate of 6.99 percent, which is actually pretty good. Some credit unions may be a percent lower, but that’s not going to make much difference in the payment. The outcome will still be the same.

Along those lines, if the lease rate is high, like .00350 (8.5% a.p.r.) and the purchase rate is low, it may make more sense to purchase. Purchasing makes sense if you like to keep your cars for at least 6 or more years. However, if you’re like most people, you want a new car every two to four years. If you fall into that category and you still purchase your cars, you’ll be spending a lot more money than you have to.

Here is the calculation again so in the future you can determine if leasing or financing is the right choice.

Lease term x Payment + Drive-offs/down + Residual value + Tax and interest on that Residual value

Compare to

Purchase term x Payment + Down payment (and don’t forget to compare the first few years of your purchase term to the lease term)


Here are a few Pros and Cons of leasing and financing

Leasing pros

• The risk for the cars value is on the bank
• You’ll be able to afford more car for less money
• During a 3 to 4 year lease term you’ll be completely covered under the factory warranty
• Versus a 60 month finance, you’ll save thousands of dollars during the lease term
• You’ll be able to get a new car without having to worry about selling your old one…you get to walk away from the car
• If used for business purposes, a tax write off may be possible

Financing pros

• You’ll have the “feeling” you’re going to own something
• You can modify your car however you want
• You can drive as many miles as you want
• Insurance coverage can be less if you choose minimal coverage
• If your gross vehicle weight is over 6,000 pounds a business tax write off may be possible
• If your intention is to keep this car for six or more years, you’ll be without a car payment

Leasing cons

• If you’re going to turn the car in, it needs to be in stock condition, making modification difficult
• If you’re going to turn the car in, the car needs to be within the contracted miles
• If you turn the car in you’ll have to pay for excessive wear and tear such as bald tires, large scratches or dents, and cracked windshields…with normal wear and tear there is no charge
• If the car is totaled, any money you put down is lost (however, GAP coverage will take care of any negative equity your car may have)
• You may not have the “feeling” of ownership
• If you continue a leasing cycle, you’re always going to have a car payment

Financing cons

• If you trade in or sell your car within the first few years, it’s going to potentially cost you a lot of money
• You don’t actually own the car until you’ve made all the payments
• You’ll have to consider spending extra money on extended warranties or suffer the cost of expensive maintenance after the factory warranty expires
• Your payment will be much higher than if you leased the same car
• The risk for the cars value and payoff is solely on you
• Your only option to get out of the car is to sell it to a dealership or private party

I hope this information helped you guys. I’m sure through discussion we’ll be adding more to this thread. Let me know if you have any questions! J

[Suprolla]

That's a very well written introduction to leasing/financing. Thank you.

[CAOSyAMOR]

Originally Posted by Suprolla

That's a very well written introduction to leasing/financing. Thank you.

lengthy.. But worth the read, well said!! +1

[ryanlip]

Thank you

[doubleapex]

I'm glad you guys found it helpful. Let me know if you have any questions!

['busa]

Great read! I'm trying to think of possible questions!

What's your background?

[paul335cpe]

thx for the analysis. just bought a new 335i coupe and am paying cash. what about comparing lease vs. financing vs. cash using similar assumptions? my situation is that I drive only 5-6K miles/yr and like to do some mods/upgrades (and like security of knowing I have no monthly payment). Am I making a mistake and paying too much? Do leases adjust for very low mileage?

[James330I]

good read

for me, it just comes down to having the new car itch every 4-5 years.

With my love of cars, I've budgeted a set amount every month for a car payment, and I expect to have that the rest of my life

Investment wise - it's a poor decision, but I like cars too much to keep one for too long

[doublearon21_e90]

Thanks for the great post, I have some anti-lease friends that say its stupid to lease and no matter how many times I tell them its not they won't listen, this is undeniable proof that a lease is better for my situation.

[MMJ4mil_e90]

does anyone have a hookup for a good priced 328i coupe


for lease? lemme know because I'm trying to get one for a family member.

[Jesse@BavarianX]

Good job on the post.

[E46Curious]

Originally Posted by paul335cpe

thx for the analysis. just bought a new 335i coupe and am paying cash. what about comparing lease vs. financing vs. cash using similar assumptions? my situation is that I drive only 5-6K miles/yr and like to do some mods/upgrades (and like security of knowing I have no monthly payment). Am I making a mistake and paying too much? Do leases adjust for very low mileage?

Paying cash could be good or bad. You need to look at what the financing rate would have been and what rate of return of say a Money market fund or a CD or savings account would be.

[Double Vanos_e90]

Great write up doubleapex, i have never clearly understood the difference between leasing and buying until now!! Thanks!

[originalrumrunner]

Thanks!

[nlakind_e90]

That was just a HUGE help!!! Thanks!

[eelnoraa]

Nice analsys. Now I will be able to convince my parent to at least consider lease.

I agree with every point you mention except one:

Under Purchasing Con section:

"If you trade in or sell your car within the first few years, it’s going to potentially cost you a lot of money"

It is true that you pay more money for purchasing than leasing for the first 3 year. But you also own the bank less money because your paid off more.

Assuming one is selling the car at the same price as the residual value. The amount of money spend for purchasing and leasing is about the same here too.

Of course, it will depend on a lot of factor like interest rate, milage .... And of course the hassle of selling the car yourself.

Please correct me if I am looking at this wrong.

eel

[doubleapex]

Originally Posted by eelnoraa

Nice analsys. Now I will be able to convince my parent to at least consider lease.

I agree with every point you mention except one:

Under Purchasing Con section:

"If you trade in or sell your car within the first few years, it’s going to potentially cost you a lot of money"

It is true that you pay more money for purchasing than leasing for the first 3 year. But you also own the bank less money because your paid off more.

Assuming one is selling the car at the same price as the residual value. The amount of money spend for purchasing and leasing is about the same here too.

Of course, it will depend on a lot of factor like interest rate, milage .... And of course the hassle of selling the car yourself.

Please correct me if I am looking at this wrong.

eel

the key word in my sentence is potentially. It MAY cost you a lot of money in the first few years--UNLESS you put a large portion of money down. But lets say you do put 5,000 down and make your 900 dollar payment every month for the first 1.5 years and then decide you want to trade it in. That means you've spent a total of 16,200 plus 5,000 down! That's a lot of juice! And what that really means is, that car cost you 1,177 dollars per month to drive. So, if you are able to sell it for what you owe...does that put you ahead of the game? ...based on what your total costs were for that first 1.5 years, i'd say not!

[gno323]

I want a new 3 series coupe and I have a 2005 A4...I put 6k down and only pay like $500 a month. I owe like 19k more...I'm financing the car. Do you think I should wait another year to get the 328 or 335 or would it be better to do it now?? Thanks

[doubleapex]

Originally Posted by gno323

I want a new 3 series coupe and I have a 2005 A4...I put 6k down and only pay like $500 a month. I owe like 19k more...I'm financing the car. Do you think I should wait another year to get the 328 or 335 or would it be better to do it now?? Thanks

That's like me asking you, what color is my dog? (without you seeing my sig!). The point is, you don't know until you've seen him.

honestly, you just need to go into a dealership, have your car appraised and pick something out you like and then work the numbers. they will either make sense to you or not...

however, don't expect to be able to get out of your audi clean. they have a fairly crummy resale value (no offense). even if you sold it private party you'll probably be a little negative.

they best way is to sell your car on your own or wait until you finish your lease...

[MAS18]

All above is correct and well done. The only real item I can add to the lease vs buy decision is the implication of a large down payment if you buy. This could significantly reduce your overall cost to own over a 3 year (compared to lease) period or 5 year loan period. If you consider a $60,000 car with 50% down you could save as much as $4,000 to $7,000 by owning depending on whether you can sell it for the lease projected residual (62% on a 335i cabrio) or more.

I currently have a 2004 - m330ci cabrio with all the bells and whistles and the lease buyout is $31,000 and they are selling for $37,00 to $39,000 privately ($41,00 at my dealers !!). So I decided that I do not want to leave this on the table along with the finance delta and tax differential on the following vehicle (after my 335i).

My calculations show me saving about $6,500 over a 3 year period against an interest loss (after taxes) of just over $2,500. $4,000 in my pocket works for me !! I also hate paying the up front lease initiation fees and the higher lease interest that you seem to always get hit with. Sellijng a 335i in 3 years at 62% (or more) residual should be a no brainer - I'll take the risk. I also really want to customize this one and not have to worry about the lease and I really hate having to buy tires with only a year left on the lease - and you will with high performance run flats - guaranteed !!

These decisions are really very personal that's why there are so many choices !!