I have seen many questions asking about leasing vs buying.
I have always bought used cars with cash and have never looked into leasing a vehicle.
I have no idea how they work. Can someone explain how it works and why most users on this site seem to feel that leasing is a bad idea?
Leases are effectively renting a car for 2-4 years. You pay a fixed monthly payment (typically after a substantial upfront payment as well) to the leasing company in exchange for the right to operate the car. You don't actually own the car; the leasing company does.
After the lease period is up, you have the option to buy the car outright for a price set at the beginning of the lease. The buyout price is typically higher than the market value of the car, incentivising most people to just turn in the car once the lease is up (and probably leasing a new car to replace it).
They're usually a bad deal because you pay more overall than you would if you took out a loan, and certainly more than if you bought the car outright. There are sometimes benefits to a lease, such as discounts on maintenance, but most often the benefits do not outweigh the additional cost.
They are not used because they're a sound financial way to buy a car; they're used by people who want a new car every few years and can get a more expensive car with the same monthly payment. That's why most commercials for high-end cars advertise their lease price and not their sales price; Paying $400 a month for a BMW sounds better than buying one for $80,000.
If you have always bought used cars with cash, then continue to do so. It is, by far, the most economical way to operate a vehicle.
D. Stanley has correctly described the process, but not a significant implication and a reason that many people do choose to lease.
If you use your car for business, the cost of leasing is probably considered an operational expense, and can be fully deducted from your sales. If you buy a car, you now own a piece of capital equipment, which not only has cost you a larger outlay up front, thus reducing your cash assets, but the cost of which can only be depreciated by a certain amount over a period of time (usually annually). Also, the residual value of the vehicle must be accounted for when you finally dispose of it.
Please note - I am describing general principles, I am not an accountant. If you will be using a vehicle other than personally, consult one to see how this might effect your business.
I like this question because I think leasing gets a bad rap as being a rental and renting is bad so don't lease. I, personally, have never bought or leased a new car, but leasing has it's place. One blind spot of the other answers is sales tax. Depending on your jurisdiction, buying a car isn't different than buying anything else and you'll owe sales tax.
In some places, like California, when you buy a car, you'll owe sales tax on the whole purchase price but when you lease a car you pay sales tax on the lease payments. California also has no other way of mitigating the sales tax. A number of states will asses the tax on the purchase price net-of a trade-in or other similar mechanism.
If you're buying an $80,000 BMW, and the sales tax is 9% that's $7,200 in just sales tax, due right now. This obviously gets worse if you do a zero down financed purchase of a car, now you're paying interest on sales tax, don't do that ever.
When you lease a car, you and the lessor agree to some amount of depreciation that will take place over the lease period to cover your use of the car. A rule of thumb is about 35% for 36 months. So rather than buying the car for $80,000 you're agreeing to pay the $28,000 of depreciation the car will experience. You agree to a usage limit, like 30,000 miles over the three years. You agree to keep the car maintained and in good shape; meaning you fix dings, dents and other damage. To that end the leasing bank may require you to keep very low deductible insurance. You also agree to fees if you don't keep up your end of that bargain. The lessor agrees to sell you the car after the lease period for the $52,000 remaining after the depreciation, this is your buy out price. After you add an interest rate (money-rate in lease jargon) and fees to the $28,000 of depreciation you'll pay something closer to $3,000 in sales tax over the course of the lease, and you don't have to pay it now.
It's for this reason that essentially all exotic cars you see, particularly in high tax areas, are leased. No one is parting with a $25,000 (or whatever) tax bill to pay cash for their Ferrari. Similarly, of you want to be in that new $80,000 BMW every three years in CA, you're not paying $7,200 in just sales tax every three years, you're leasing it.
With that in mind, some cars "lease well" which means the financing bank assumes a small amount of depreciation, while other brands/banks are more "lease to own" where a lot of depreciation is assumed and you'll have a lower, generally below comparable, buyout price at the end. As D Stanley points out, the cars that "lease well" will have a high, generally higher than comparable market, buyout price when your lease is over. To some extent, cars that lease well also incentivize you to lease your next car too. So when you're shopping pay attention to the residual value, different brands/banks treat this differently. If a Mercedes, BMW, and Audi all have an $80,000 sticker price and the same money rate of interest, they'll still have very different lease prices because of this difference in depreciation philosophy.
The sales tax issue is more like salad dressing than a meal in terms of benefit, and is really only something to consider after you've decided you're going to spend the money to be in newish cars every few years.
Assuming this is not a business expense, because leases have bookkeeping benefits in that context, it's probably more financially sound over the long term to buy well negotiated used or certified pre-owned cars, and never ever include fees or taxes in the amount you finance. Whether you're leasing or buying, the car is still going to lose 30-40% of it's value in the first 3 years. Generally, the only way to win with cars is to keep them for a long time. Newer, more expensive, cars command more expensive maintenance and repairs, more expensive insurance, and you eat depreciation for breakfast lunch and dinner. Whether you're paying interest on a loan, or a money rate on a lease, renting, or ubering everywhere, or whatever; a car is an expense. And, probably, the best way to minimize the expense of being in a new BMW every three years is to lease it. But, generally, the best financial move is to avoid the first few years of a car's life.
First off, lease=long term rent, just as it does with housing. You do not get any equity in the item, and you are generally less responsible for maintenance. You may have an option to buy at the end of a lease, but that is not a given. If you have an option to buy, it may be at a reduced price or it might not.
If you’re rich, you buy the car outright and then dispose of it whenever you want to as the amount is irrelevant. If you are poor, you buy used and hope for the best, if you’re middle class you buy new and then plan on keeping it for at least a few years after paying it off.
But if you’re well off, but not quite rich, leasing a car can makes sense if you want to use a new vehicle without worry about maintenance expenses. The thing is, if you buy a car, no matter how well you do the routine maintenance you are liable to eventually either need to preemptively do a major repair or deal with the vehicle being inoperable for a period of time. If you lease a new vehicle, you will need to do very little routine maintenance (which should be covered as part of your lease) and should basically have no downtime. Leasing thus allows you to have a new car at a constant expense. If you can afford the expense, it is an easy way to manage things.
I leased a scion tc for 2 years. I was in graduate school and I did not know how far I would be going once I graduated (so I did not want to buy a car then have to drive it). Over those two years I payed around 6k. The car ended up depreciating about 8k in the time I had it. So In a sense I came out ahead. Also It was in an accident that required 10k worth of repairs (which the insurance picked up). But I am sure that would also have depreciated the value of the car if I had had to resell it. Of course for 6k I probably would have been able to buy a decent used car and I would still have that now.
Congratulations on always buying used cars. You have saved big money by avoiding the huge depreciation of a new car. One additional choice that was a new concept maybe 30 years ago, was a blend of a conventional loan, and a lease. It was a loan with a huge balloon (final) payment. That allowed a lower monthly payment that was promoted to compete with the lease's lower monthly rate.
The car dealer could then convince the purchaser to trade-in the car before the big balloon payment. In practice, that often lead to negative equity value on the trade-in. It was promoted of all the advantages of ownership and leasing. I called it all the disadvantages of both. Now that is such a common option, you just need to be sure to ask if there is a balloon payment.
