To Lease a Car or Buy a Car?

When it comes to advice from personal finance experts, car leases usually get a bad rap. Financial gurus like Dave Ramsey tack a very dim view of leasing, suggesting it is just another way of racking up consumer debt.

But are the dangers of making the decision to lease versus buy your car overblown?

Industry expert Mark Ragsdale thinks so. According to his reasoning, getting a car lease can be a financially sound and smart way for consumers to get the wheels they want.  

“Unfortunately, there is not much that consumers can control in the new and used car markets,” says Ragsdale, former car dealer and author of Car Wreck: How You Got Rear-Ended, Run Over, & Crushed by the U.S. Auto Industry. “While they are driving their cars and making payments, automakers are heavily discounting and flooding the market with the exact same models. These decisions do more than just knock a few pennies off the value of their customers’ car already on the road. Some of these moves can destroy up to 60 percent of the value of a car in its very first year of life.”

And the poor car buyer doesn’t simply have to contend with the automakers’ marketing decisions that lessen their car value. Toyota's recent trouble reminds us that safety issues, heavily covered by the media can also have a significant impact. Following Toyota’s recalls, which began in November 2009, the value of its cars fell by as much as $2,000. So if you were a consumer driving a 2008 Toyota Camry, one of the models affected by the recall, you also lost equity in your car. At the dealership, the quick and dirty solution to lost equity is rolling the deficit into the next auto loan, but that is hardly a recipe for financial success.

“Rolling unpaid auto loan obligations into newer loans is what got the industry into so much trouble,” says Ragsdale. “The vehicles are simply not worth what consumers owe on them at trade-in time. So both the payments and the length of finance terms increase in order to compensate for old debt obligations added into the new purchase contracts.”

If you own one of these vehicles as this unpredictable depreciation occurs, you also own all the financial losses that come right along with it, says Ragsdale. He points out than in this era of long-term finance controls, very few consumers ever truly own their cars these days: The banks do. Ragsdale suggests the consumer is better off letting the banks own the depreciation too.

He points out that the average term of car finance has grown to 64 months, while the average term of customer “ownership” is just 39 months. That's where a car lease can be a benefit rather than a curse. With a short-term lease contract, consumers don’t have to worry about what their cars will be worth in the future. At the end of the lease, the consumer simply drops off the keys and walks away debt-free -- but also car-free.

In general, a car lease offers about the same payment as a purchase contract for half the term. For example, a 72-month payment of $300 per month for a car purchase is roughly the same as for a 36-month lease, saving half the number of payments paid out of pocket. If you elect the longer-term traditional financing instead of the shorter-term lease, you will invest another $10,800 in that vehicle before you ever see the title. That’s before you add in all the extra maintenance expenses and repair liability, which can increase dramatically during the fourth, fifth, and sixth years of ownership.

According to Ragsdale, consumers are underwriting all this resale risk with no chance of ever recovering their extra investment.

Electing a longer-term finance strategy with plans of trading out of the problem halfway through the contract is not a viable alternative either. Thirty-six months into the purchase agreement, most consumers still owe more principal and bank interest on their loan than the car is worth. So the only way to make a deal is by rolling the remaining unpaid balance into the new loan at trade-in time. This dynamic could put customers further upside down each successive time they trade. On the other hand, at the 36-month point, the leasing customer will have no negative equity…or positive equity, for that matter.

“So on one hand, we have 15 percent of consumers staying even by leasing their cars,” Ragsdale said. “On the other, we have 85 percent of consumers putting themselves further and further into debt so they can ‘own’ their cars. This is a needless waste of money and a needless strain on auto lenders. Should life’s circumstances change -- as they inevitably do -- consumers always ‘own’ the right to completely wipe out their personal auto debt every three years -- a critical point the personal finance gurus fail to consider.”