The Truth About Car Leasing
If you’ve been to a car dealership recently, there is a good chance the salespeople tried to get you to lease a car. And most often they make it sound so appealing. A brand new car with low monthly payments. Much lower than if you were to buy the car with a loan. You could imagine yourself just driving out of the parking lot with that shiny new ride.
However, what they don't tell you is that there are some major drawbacks to leasing a car. So in this post, we are going to discuss the truth about car leasing. Why it might not be the best decision for you when you are thinking about acquiring that next vehicle.
Why Leasing A Car Is Tempting
Let’s first talk about why leasing a car is so tempting.
Lower Monthly Costs
For one, the monthly payments are often lower than if you were to purchase the same car with a loan. This is because you’re only paying for the depreciation of the vehicle during the lease term, plus any interest and fees. You’re not paying off the entire value of the car like you would with a loan. If you are tight on cash, this is super tempting. You not only get to drive a brand-new car, but it feels like you are getting a deal with a lower monthly payment.
A New Car Every Few Years
Another reason people are tempted to lease is that you get to drive a brand-new car every few years. With a loan, you’re stuck with the same car until it’s paid off, which will be at least several years. And when the car is paid off, your car no longer has that new car feel you felt when you first purchased it. But with a car lease, you get to enjoy that new car smell every 2 to 4 years. What more can you ask for right?
Maintenance Packages
Another reason leases are so tempting is that some leases also come with maintenance packages that cover things like oil changes and tire rotations. If you get annoyed by the constant oil change expense and small maintenance fees you have to pay every time you visit the maintenance center, this too is also very tempting.
No Resale Worries
And last is no resales worries. When you are done with the lease, you simply return the car. You don’t need to worry about finding a buyer or going through the hassle of selling your car. The only thing you have to worry about is paying any end-of-lease fees, including those for abnormal wear or additional mileage on the vehicle. So, as you can see, there are some definite advantages to leasing a car. That is if you are only focused on the items we just talked about. Let’s talk about some drawbacks to leasing. And some big ones at that.
01 - No Equity
The first biggest drawback of leasing a car is you aren’t building any equity in the car when you are leasing. Yes, cars depreciate in value over time, unlike a home. A well-purchased home will appreciate in value over time. But pretty much all cars are worth less today than they did yesterday. So it probably isn’t the best place to try to build equity if you are trying to build wealth.
However, when we compare the lease to the loan, at least with the loan, each monthly payment is bringing you closer to owning the car outright. When you’ve paid off the car loan is yours. Free and clear. But with a lease, you never own the car. At the end of your lease term, you simply turn in the keys and walk away. There’s no equity to trade in or sell when you’re done with the car.
And if you decide you want to keep the car, you’ll have to pay a hefty purchase price to do so. Or you have to start the process all over again with a new car lease. Therefore when you lease cars, you are always making car payments because you are just jumping from one car to another. So, if building equity in a vehicle is important to you so you can one day outright own it, leasing is definitely not the way to go.
02 - Very Specific Terms
The second major drawback to leasing a car is that car leases often have very specific terms. And terms that are hardly ever in your favor. For example, most leases have a mileage limit. Generally, this limit is anywhere between 10,000 miles and 15,000 miles per year.
If you go over that limit, you’ll be charged a per-mile fee. For every mile that you add to your annual mileage, you can expect to pay anywhere from 10 cents to 50 cents per mile extra. And those fees can add up quickly.
If you’re someone who has had to travel frequently over the course of your lease agreement, you can expect to be paying substantially more out of pocket for these terms. According to the Department of Transportation, the average driver drives around 13,500 miles per year. So if you happen to be above the average, you can expect to pay quite a bit in mileage penalty when you are ready to turn your car in.
Most leases also require that you get the car serviced at specific intervals and only use certain types of oil and filters. If you don’t adhere to these terms, you could be charged a hefty fee when you turn in the car. And lastly, leases typically have very strict guidelines about what types of damage are considered “wear and tear” and what type of damage will result in fees.
Should your car have any damage or wear and tear that has reduced its overall functionality or appearance, you can expect to pay additional fees for this as well. These types of additional leasing terms and expectations can often be what makes or breaks the leasing experience for many. If you don’t want to have to deal with paying extra when something comes up for you, it’s best to buy a car right out instead.
03 - Penalty With Exit
The third major drawback to leasing a car is that car leases are not easy to exit and when you try, you are hit with a hefty penalty. Leases are typically for a term of two to four years. And during that time, you’re locked into making monthly payments.
If you decide you want to get out of the lease early, you will be hit with a hefty penalty. This penalty is typically equal to all the remaining monthly payments on the lease agreement. So, if you have two years left on your lease and you decide to exit early, you can expect to pay all 24 of those remaining monthly payments as a penalty.
And that’s not even including any other fees or penalties that might be associated with early termination. Thus most often, people are forced to see the lease through till the end whether they like it or not. I know of many people who want to improve their finances by getting rid of their current car payments.
Unfortunately, they realize too late that they are stuck in a car lease contract that has outrageous penalties for canceling early. If you’re someone who likes to have flexibility or simply wants to be able to get out of their car lease agreement without penalty, then leasing is definitely not for you.
04 - Higher Car Insurance
The fourth major drawback to leasing a car is that leased car insurance costs are often higher. When you lease a car, the leasing company will require that you carry full coverage insurance on the vehicle. The dealer wants the car back eventually in good condition, so they will require you to insure it with good protection.
And full coverage insurance is not cheap. In addition, many leasing companies also require that you purchase additional insurance coverage like gap insurance. Gap insurance covers the difference between what you owe on the lease and what the car is actually worth in the event that the car is totaled in an accident.
And this coverage can also be quite expensive. When you are leasing, you have less say in a lot of your financial decisions. Decisions like how much insurance to have or not. So, again if you’re someone who likes the flexibility and is looking to keep your car insurance costs down, leasing a car is probably not the best option for you.
05 - No Modification
The fifth major drawback to leasing a car is that you are not allowed to do any modifications to a leased vehicle. Are you the type that likes to make alterations to your car to customize it for your personal preference? Or maybe just something small. Like tinting your windows because you like privacy.
Well if you are leasing a car, the probability that you can make such modifications is low. If you do make even small modifications, you’ll likely need to revert it back to its original state. Such as removing the tint from your windows before taking it back to the dealer.
Leasing companies want the car returned to them in the same condition as when it was leased because they need to think about resale. So any modification that you do to the car will likely come with some penalties or even possibly void your lease agreement. So, if you’re someone who likes to personalize their cars or likes to modify them for any reason, leasing again is probably not the best option for you.
06 - Car Lease Is Highly Marketed
The sixth major drawback to leasing a car is the fact that car dealerships highly market car leases. Almost to a point of annoyance. When we lease a car, we are essentially just renting the car from the dealership for a set period of time. And at the end of the lease, we have to give the car back to them. So, in essence, we are just giving the dealership money month after month with nothing to show for it in the end.
And car dealerships know this. That’s why they are always trying to push leases on unsuspecting customers. It is ridiculously profitable for them. The dealership makes money on a car lease in several ways. First, the dealership will mark up the price of the vehicle above what it is actually worth. This difference between the actual value of the vehicle and the selling price is called "residual value."
The higher the residual value, the more money the dealership will make when the lease is up and the car is returned. In addition, the dealership will also charge interest on the lease. This interest is called the "money factor." The money factor is similar to an interest rate, but it's typically much higher.
So, not only will the dealership make money on the difference between the selling price and the actual value of the car, but they will also make money on the interest charged on the lease. All in all, it's a pretty sweet deal for the dealership, but not so much for the person leasing the car.
My general rule of thumb is this. When a product is so highly marketed, I can’t help but be suspicious of why. Most often the company isn’t marketing them so they can best serve their customers. Rather they market it because the margins on that product are so high compared to their other products. Be wary when you are being sold certain products. You aren’t buying the product because you want it. Rather you are buying because of the marketing,
