Getting smart about leasing cars
Q: I’m thinking about getting a new car. I have always paid cash for my cars, but the car dealer is trying to talk me into a lease. I was always under the impression that leasing is for suckers. What do you think?
A: I wouldn’t say that leasing is for suckers, but you need to be careful when you consider leasing a car. If you don’t know what to look for, you can’t get the best deal. Here are four things to keep in mind if you want to be smart about your lease decision.
First, compare the agreed-upon price of the car, sometimes called the capitalized cost, with the car’s residual value, or the estimate of what the car will be worth at the end of the lease. A large part of your monthly lease payment will go to compensate the owner of the car (known as the lessor) for the difference between these two values.
Second, take a look at the implied financing cost. In addition to depreciation, your lease payment will compensate the lessor for the capital tied up in the car while you are leasing it. The implied financing rate is reflected in something called the “lease money factor”. The money factor is an innocuous little number usually expressed in a form like: 0.001234. The lease factor is not an interest rate, but the two are related. In fact, you can convert a money factor into an annual percentage rate (APR) by multiplying the money factor by 2400. Once converted to an APR, you can check to see if the borrowing rate built into your lease is competitive with the rates on car loans.
Third, take a look at the mileage allowance compared to how much you usually drive. The mileage allowance will usually be between 10,000 and 15,000 miles per year. If you exceed your allowance, you will usually be charged for excess mileage at a rate somewhere between $0.10 and $0.30 per mile.
Finally, try to get a sense of what the lessor means by “excessive wear and tear.” The lessor is trying to protect the resale value of the car. When you return the car, it will undergo a thorough inspection looking for dents, scratches, windshield chips, carpet stains, worn tires, scuffed wheels and anything else that will hurt the vehicle’s resale value. If they find any of these things, they will charge you whatever they feel is necessary to fix them.
Remember that all aspects of the lease are open for negotiation. You can expect the lessor is going to use all of them to make the deal as profitable for them as they can, so you need to work it, too. For example, you should negotiate the starting price of the car just like you would a purchase, but you must also keep an eye on the residual value. The lessor could give you a good deal on the car’s starting price, but take it back by giving you a lower-than-realistic residual value.
I recently had a representative of Tesla run a lease versus purchase comparison for a Model S. On a three-year lease, I was surprised to find their assumed residual value to be only $49,777—below the asking price of a slightly inferior used Model S with over 52,000 miles currently listed on their website. I was also surprised to find a lease money factor of 0.002191. That equates to an APR of 5.26 percent, significantly higher than the 3.50 percent they were quoting for the 72-month loan on the purchase option. By comparison, the APR for a lease is often less than the APR for a car loan.
As Tesla demonstrates, a lessor can pull many levers to increase the deal’s overall profitability. By assuming a lower residual value and higher financing cost, Tesla created a higher monthly payment than they would otherwise get. In fact, the monthly payment for the Tesla lease is slightly higher than the payment for buying the car outright. Not a bad deal—for Tesla.
Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions that you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to: firstname.lastname@example.org