StatmanDesigns

I find that many people do not understand how car leasing works. I am a HUGE fan of leasing new cars, and I will share my thoughts and the basics of why leasing can be a great deal.

My 993 is different in that it is an extra car that I am planning on keeping for a long time. It is also a very slowly depreciating asset. The logic of leasing does not make sense for my 993 purchase and I paid cash for it. On the other hand, my wife's daily driver (an Audi A4) is leased.

The main benefit of leasing versus buying a new car is that with a leased car you can get a higher valued car for the same monthly payment. Or a lower monthly payment for the same value car, either way. You also get to drive a relatively new car all of the time that is never outside the warranty period.

Basically the idea behind a lease is that you pay for the depreciation of the asset over the time period of the lease and interest on the non-depreciated portion of the purchase price. Even if you bought the car outright you still would not own the depreciated part of the purchase price. That value has evaporated either way. The reason you "own" nothing after the lease ends is because you never paid for anything more than the depreciation. If you had bought the car you paid for the depreciation PLUS the residual value, and now you own the residual value. Since you don't pay for the residual value with a lease, your payments are cheaper.

When you enter into a lease agreement for a new car you do not get to choose the residual value, the bank or leasing company sets the residual value as a percentage of the capitalized cost (purchase price) based on previous models from this car maker. They are only guessing, but it is a self-fulfilling prophecy since thousands of cars will come off of lease at this residual value. It generally varies from about 50% to 63% on a 36 month lease. Audi and BMW are in the 63% range and Subaru is in the 50% range. This means a $30K Subaru WRX Sti will have a residual value of about $15K after 3 years, while a $30K Audi A4 will have a residual value of $18.5K after 3 years.

The "money factor" is another way of describing the interest rate on your lease. Interest rates are usually defined as APR or annual percentage rates while money factors are based on 1/24 of the APR. The reason this is done is to help calculate the monthly payment and to make a really small number that "looks good" to the buyer. The money factor is used in an equation that averages two values and then needs a monthly interest rate. When averaging two numbers you add them together and divide by 2, and a monthly interest rate is the APR divided by 12. If you divide by 2 and then divide by 12, you are dividing by 24 and that is why the money factor is the interest rate divided by 24.

The capitalized cost is the agreed upon purchase price of the car. This is what the dealership will get from the leasing company. The dealership does not care if you buy outright or lease, they get their money up front either way. You still need to negotiate the capitalized cost of your car when leasing. Any down payment will be used to lower the capitalized cost, but I never put any money down on a lease.

You can think of your lease payment as having three components: 1) Depreciation payment, 2) Interest payment, 3) sales tax.

The depreciation payment is the capitalized cost minus the residual value divided by the number of months in the lease. The interest payment is the interest on the residual plus the interest on depreciation that hasn't occurred yet. If we assume a $30,000 cap cost and a 60% residual value ($18,000), with a money factor of 0.0019 (4.56% APR), and a term of 36 months we get the following payment:

($30,000-$18,000)/36 + ($30,000+$18,000)*0.0019 = $333.33 + $91.20 = $424.53

And we need to pay sales tax on that payment. In Ohio the tax is 7% which is $29.72 per month and they make you pay all 36 months of sales tax up front. This adds $29.72*36=$1070 to the initial cost. This can be rolled into the capitalized cost to spread the tax payment over the 36 months, but you pay interest on the tax unless paid up front.

In the above calculation the interest payment has two terms ADDED together, and this really should be divided by 2 to get the average of those numbers. However, the money factor all ready has that factor of 2 incorporated.

So with this example, you get to drive a $30K car for 3 years at $450 per month. The car is under warranty the whole time and you give it back after 36 months and get a new one. You have put no money down except for a security deposit of about $450. If you purchased the car with an APR of 4.56% your monthly payment would be approximately $890 per month for 36 months, $685 per month for 48 months, or $560 per month for 60 months plus you owe sales tax on the $30K up front. Sure you don't "own" anything after the lease ends, but you didn't pay for that ownership either.

One danger with leasing is that the payment is so much lower than a purchase, and the dealer will try to rip you off by padding the numbers and making a higher payment. Most people never know because they don't understand any of the above calculations. There is a dealer "reserve" which is added into the capitalized cost, but it is not disclosed. $200 per $10K purchase price is an acceptable amount of "extra" cost to allow, but many times dealers will try to jack he cost up by thousands of dollars. Before signing a lease you can calculate what the payment should be with the above formula, and then figure out the dealer reserve that has been added in.

So even without a business related tax deduction on the lease, it can still save quite a bit of monthly expense and sales tax. Hope this helps somebody.

cmoss

Always paying never owning. I suppose renting works for some. I personally balk at at laying out lots of money and then giving the car back.

Why not just buy the car outright, then sell in a couple of years. The depreciation should be the same, but there are no interest payments. Now if I could deduct the intest on my taxes it might be more attractive.

I DO think leasing makes alot sense for a business (self employed or otherwise).

Bruce SEA 993

The other thing to look for is the number of miles allowed for per year. There are lots of attractive lease rates with a max of 10k miles per year. Out here in the wild West, us sales people put on too many miles!

Any way around that...I always buy.

StatmanDesigns

Only if you have the money sitting around in a no interest savings account. Of course, you have ignored the time value of your money over the length of ownership of your car. Your money could be doing other things for you: earning interest, purchasing a home that is appreciating, etc. Why would you EVER want to dump all that money up front into a depreciating asset? It makes absolutely no sense; common or financial.

As I said in the beginning of my post, my 993 is different. It is a slowly depreciating asset (if at all) and I plan to keep it for a long time, so I paid cash for it. Any new car just doesn't fall ino that category, and never could.

You don't own anything after the lease ends because you didn't pay for anything to own. You seem to be the perfect candidate for learning about leasing through my original post.

Greg Fishman

In theory the depreciation is the same but it is tough to sell a used high end car and it is a major hassle. In my eyes the main benefit of a lease is that you are locked into a given value (residual) at the end of the lease. If the market bottoms on the car you just let the bank deal with it, if the market is higher than the residual either keep it and purchase for the buyout price or sell it and make a small profit. Also what if the car is in a bad accident and although repairable the market value is killed. Leasing protects you from that situation too.


My wife and I put so many miles on a car leasing isn't a good decision for us and since she is self employed there were some serious tax benefits we recieved when she bought her Yukon, but I can certainly appreciate why people lease.

Father of 3

The other alternative, which is what I do, is to be on the other side of the "difficult to sell a used high end car" connundrum. I buy slightly used cars (infiniti, bmw, toyota sienna - you know that had to be on the list) and keep them forever.

StatmanDesigns

If you drive your car for business then you get to deduct your miles. Any lease can have as many miles per year as you would like. Generally you are charged $0.15 per mile if you purchase them up front, or $0.30 per mile if you go over at the end of your lease period. I generally lease for 12K miles per year, but to bump it to 15K miles it would cost 3000*$0.15/12=$37.50 additional per month.

Remember that if you purchase a car and drive a lot of miles it depreciates faster, so you end up paying for the miles either way. In excessive mileage cases it is almost always better to purchase rather than lease.

Greg Fishman

Another thing is to look at is assuming a lease from someone who wants out. www.swapalease.com Sometimes you can see some good deals. I had a deal pending on a 2001 M3 with 10k miles. It had 16 mnths left at ~$700/month and 25K miles remaining. Unfortunately the paperwork took a long time and the guy got impatient and sold it to a cash buyer.

flatair

"Also what if the car is in a bad accident and although repairable the market value is killed. Leasing protects you from that situation too."

Greg hit the nail on the head as far as a benefit of leasing. Coupla other things:

As far as residuals go, lease companies usually go conservative and rarely lose money because the market for a car is less than what they predicted at the end of a lease. Sometimes however, you can get a good residual with factory subsidized leases if they're trying to move cars.

In most (if not all) states, your taxes are based only on the total lease payments, not the total value of the car (which saves quite a bit). BUT I believe you can do a similar thing with financing - you can get a tax credit if you trade in your old car for another at a dealer.

Most leases allow you to pay off the residual amount, including selling the car. Thus if the lease company predicts a conservative lease residual, and your car holds its value quite well, you can come out with positive equity by selling the car and paying off the lease.

Most lease companies are sticklers for good care, meaning if the car is beaten up when you turn it back in, or mileage is over, they'll nail you - again usually better to sell the car and pay off the lease.

Basically, leasing is mostly like a restructured loan (like a balloon loan) with some agreements made before the lease begins. Typically the equivelant interest rate for a lease is significantly higher than a loan though, especially with leasing a used car where interest rates can be insane. The real only difference is the legal 'owner' is actually the lease company, which confounds us in NY State as our legislation won't revoke 'vicarious liability', and most lease companies have pulled out of NY State

seege

Thanks Daniel.......very informative thread.

deleonl1

Another good reason to lease is because the wife wants to.

My wife doesn't want to drive a car into the ground and would like a new one every few years. It would be a waste for us to buy and sell and buy and sell.

Me on the other hand, I like to buy older cars or cars with high mileage or something special like a 993...hopefully one day soon!

Pete Lech

Excellent explanation of leasing, Dan.

From my viewpoint, at this time I could invest money in the stock market (recently a depreciating asset for many) or put it in savings which is paying maybe 2.5%. I also could borrow on my home equity line at 4.5%, which is deductible whereas a lease payment is not, as I am not self employed.

As far as driving a car with a low payment, I typically buy a desirable car that is 2-3 years old. and keep it for a long time. I prefer NO payment for 3 - 4 years. Then I could use this time to do another Porsche purchase.

John95cab

The problem with leasing here in Northern Virginia is that you get socked with 100% of the car tax. Personal ownership gets you 80% of the value up to $20k tax free but a leased car is owned by a business so you pay 100% of the tax up to full blue book value. You think you got a deal leasing a $40k car for $450/month with nothing down until you get that first $2000 tax bill which gets tacked onto your payment. Also a photo radar ticket from another state got sent to the leasing company which they paid and they turned around and tacked that onto the monthly payment.
I leased several medium duty trucks with essentially unlimited mileage and I would do it again but I'll never lease another car in VA again.

laurence '97 C4S

"Why would you EVER want to dump all that money up front into a depreciating asset? It makes absolutely no sense; common or financial."


For starters, there is no such thing as a free lunch. By leasing a vehicle, you are paying for the privilege to borrow money from a financial institution. They are pricing their service to make a positive return, which you are footing the bill for. Generally speaking, the cost of financing in a lease is substantially more expensive than financing the asset yourself (assuming no business tax deduction). The simplest way to see this is to look at the cost of financing imbedded in the lease against the equivalent risk free interest rate (i.e. Treasury note of similar duration). Now some will say that I can put my money in the stock market (or other asset like real estate) and get a much higher yield. This may or may not be true as to POTENTIALLY getting a higher yield. However, you are mixing risk classes and therefore not a relevant (consistent) comparison.

IMHO, the only reason to lease (from a financial perspective) is that you do not have the financial wherewithal to purchase the car or you get substantial tax benefits that overcome the high cost to finance. Or I suppose your crystal ball is much better at assessing residual values and you see an arbitrage opportunity. All this having been said, many like the convenience of handing the keys back at the end of a lease period, which is okay. Just remember you are paying for that privilege.

cmoss

In the end, I would think that the only metric that really matters would be the $/Mile number. For some, leasing may provide the lowest number, while for others it may be outright ownership.

And as far as the time value of the money saved by leasing, well that money has to go somewhere. Somehow the stock market strikes me as much more of a gamble. So if we stick to "safe" investments the rate of return would have to exceed the loan interest rate. And at 4.56% apr this seems unlikely.

Chris