Your Next Car: Should You Buy Or Lease?
This Financial Guide gives you a framework for deciding whether leasing a car makes sense for you. It explains the meaning of various lease provisions, as well as the initial, ongoing and final costs of leasing. Finally, it gives you the information you need to negotiate the best possible lease.
Will you save money leasing a car instead of buying one? It depends on (1) what kind of deal you strike with the dealer, (2) how many miles you drive a year, (3) how much wear and tear you put on a car, and (4) what you will use the car for (i.e. personal or business use).
In order to decide whether to lease or buy, you need to consider all of the factors involved in both leasing and buying such as:
- Initial expenses
- Ongoing costs
- Final costs
- Option rights
- Whether you are able to deduct any or all of the costs of the car for business use
- Whether having an ownership interest in the car is of overriding importance to you
This Guide also contains a list of questions to use when negotiating with the dealer to ensure that you don't neglect to ask about any charges or lease terms that might enter into your analysis.
There are two types of lease arrangements: closed-end ("walk-away") and open-end (finance). Here's how they work:
Closed-End Leases: The Dealer Bears the Risk Of Depreciated Value
When a closed-end lease is up, you bring the car back to the dealership and "walk away." the car must be returned with only normal wear and tear, and at or less than the mileage limit stated in your lease. Since the dealer, and not you, is bearing the risk that the value of the car at the end of the lease will go down, your monthly payment is generally higher than with an open-end lease.
Open-End Leases: You Bear the Risk of Depreciated Value
With an open-end lease, you bear the risk that the car will have a certain value, called the estimated residual value, at the end of the lease. In this case, the monthly payment is lower.
When you return the car at the end of the lease, the dealer will have the car appraised. If the car's appraised value is equal to the estimated residual value in the agreement, you won't need to pay anything at the end of the lease term. Under some contracts, you can even receive a refund if the appraised value is greater than the residual. If the appraised value is less than the residual value, however, you may have to pay all or part of the difference.
Tip: If you disagree with the value arrived at by the appraiser, you may choose to have an independent appraisal made at your own expense, and then try to negotiate an agreement with the dealer as to the residual value. Try calling other dealerships to find an independent appraiser or a vehicle appraisal service.
Your total cost of your lease includes:
- Initial expenses
- Continuing costs
- Final costs
- Option costs (if any)
The amount of money that a dealer can collect at the end of the lease period is regulated under the federal Consumer Leasing Act (CLA). The CLA states dealers cannot collect more than three times the average monthly payment, except as follows:
- The vehicle has unreasonable wear and tear or the mileage is greater than that specified in the lease
- You agreed to pay an amount greater than specified in the original contract
- The lessor wins a lawsuit in which they asked for a greater amount
The dealer also has the option of selling the car at the end of the lease term. If the car is sold for less than the residual value stated in your leasing contract, you could be obligated to pay as much as three monthly payments to make up the difference.
Tip: Although dealers will generally not risk the goodwill of their customers and sell leased cars for less than the residual value just to move the car quickly, during the negotiations phase you may want to include the right to approve the final sales price of the leased vehicle as part of your lease agreement.
Your Initial Lease Expenses
The first step in deciding whether to lease or buy is to find out what your initial (upfront) expenses are. This figure is part of the total dollar amount that you will use to compare with the cost of buying with leasing a vehicle.
Initial costs are the down payment you must come up with when you lease a car and include the security deposit, first and last lease payments, capitalized cost reductions, sales taxes, title fees, license fees, and insurance. With a lease, the initial costs usually total less than the down payment typically needed to buy a car. Further, all initial costs are subject to negotiation during the bargaining period with the dealer.
As mentioned previously, the federal CLA requires the lessor to disclose all up-front, ongoing, and final costs in a standard, easy-to-read format.
Security deposit. The lessor is allowed to keep the security deposit if you owe money at the end of your lease or if you missed a monthly payment. The security deposit can also be used by the dealer to cover any damage to the car or mileage that is in excess of the limit specified in the lease. If you do not owe any money on the lease at the end of the term, your security deposit is returned to you.
First and last lease payments. The first and last months' payments are usually required to be put down at the beginning of the lease agreement. Under some agreements, the last payment might be waived if you have a good credit rating--so be sure to ask about this.
Capitalized cost reduction. This is similar to a down payment. The dealer may ask you to put a certain amount of money down before leasing. The amount of the capitalized cost reduction varies with the business custom prevalent in that specific geographic area and the credit rating of the customer. The larger the down payment, the smaller the monthly payment under the lease typically is. However, most people who want to lease instead of buy don't want to put down a large down payment, and the lack of a down payment is one of the major advantages of leasing.
Tip: Trading in your old car can reduce your down payment and/or your monthly payments.
Sales tax, title fees, and license fees. The CLA requires the dealer to disclose sales tax, title and license fees in writing. It also requires the dealer to tell you what type of insurance coverage is required. In addition, some states apply a "use" tax, which is similar to a sales tax, but is added to each monthly payment.
Ongoing Lease Costs
Next, you must determine what the ongoing costs of leasing are. Typically, these include monthly payments, and repairs and maintenance.
Similar to a loan, the monthly lease payment is dependent on the term of the lease, the initial "purchase price" of the vehicle and the implicit interest rate. Unlike a loan, another important factor is the "lease-end" or "residual" value. This is the expected value at the end of the lease term.
In a lease situation you are, in effect, paying for the difference between the initial purchase price and the residual value. You should negotiate the best possible (lowest) purchase price. This will lower your cost of leasing the vehicle. If this is a closed-end lease and you do not intend to purchase the car at the end of the lease term, you should also try to negotiate a higher residual value
Example: If you walk into a dealership and ask to lease a car, they will often try to base the lease on the Manufacturer's Suggested Retail Price (MSRP). You would never pay this sticker price to purchase a car for cash, and you should not do so in a lease situation. First negotiate the lowest possible price on the vehicle, and then negotiate the lease terms.
For example, assume a car has an MSRP of $36,955 (and the lease provides for a term of 36 months, an implicit interest rate of 6.67% and a residual value of $25,895). Based upon this MSRP, the monthly lease payment would be $481.50, excluding sales/use tax, licenses, etc. The invoice (dealer) cost on the same vehicle is $32,469 (see Info Sources at the end of this Guide to find out how to get this information.) If you negotiated a price between MSRP and invoice, say $34,750, the lease payment would be reduced to $416.00.
Tip: In some cases professional guidance might be helpful in comparing the continuing costs of buying.
Note: Purchasing the same car at the negotiated price under the same terms with no down payment would result in significantly higher monthly payments of $1067.74.
The CLA requires dealers to disclose the total number of payments, the amount of each payment, the total amount of all payments, and the due date or schedule of payments. There is usually a penalty for late payment, which the lessor must disclose to you as well.
- In a "maintenance lease", the dealer assumes the maintenance expenses. Conversely, in a "non-maintenance lease," the customer assumes these expenses. If the dealer is to provide repair and maintenance, you will have to bring the car to the dealership in accordance with the manufacturer's suggested schedule in order to keep the warranty coverage.
- The lease may contain a "budget maintenance" provision, authorizing the dealer to collect a set amount from you each month for maintenance. If maintenance expenses are incurred, the dealer deducts them from your maintenance account. At the end of the lease, you'll either have to make up the difference or, you'll get a refund if you've deposited more than was used. If you would like extended warranty coverage, some dealers offer it at extra cost.
Tip: Lease agreements often require that a minimum level of insurance be maintained on the vehicle. You should consider whether your continuing insurance costs are higher on a lease than on an outright purchase. Also watch out for lease provisions where the lessor will purchase the insurance and bill you for the amount. This can be more costly than if you arrange the insurance yourself.
Your Final Costs
- Excess mileage charges
- Default charges
- Excessive wear and tear charges
- Disposition charges
Excess mileage charges. Mileage limitations usually occur with a closed-end lease. If you have gone over the allowable mileage at the end of your lease, you will have to pay a fee. With an open-end lease, although there is no penalty, if you exceed the mileage limit the appraised value at the end of the lease term will usually be lower.
Tip: Consider carefully whether the mileage allowance is enough. Make some calculations of the miles you have driven per week, month, and year to find out whether the mileage allowance is sufficient. Be aware that the low-mileage lease deals currently popular in certain areas offer mileage limits that are insufficient for many people. If you think you need more than the allowable mileage, negotiate a larger mileage allowance in your lease.
Tip: If you stay under the mileage limit, you don't get a refund.
Default charges. These cover any payments or security deposits that the dealer does not receive from you and legal fees and costs the dealer incurs to repossess the car.
Excessive wear and tear charges. You'll have to pay charges for excessive wear and tear when you return the car at the end of the lease, unless the contract reads otherwise. The dealer must tell you in writing the specific definition of excessive wear and tear. Generally, it means anything beyond normal mechanical or physical usage.
Disposition charges. These are the costs of cleaning the car, giving it a tune-up, and doing final maintenance. If the agreement does not state otherwise, the dealer may pass these costs on to you.
Your option rights include the right to (1) purchase, (2) extend or renew, and (3) early termination.
Purchase Option. Your lease may include the option to purchase the car at the end of the lease term. This option is usually found in open-end rather than closed-end leases. Under the CLA, the dealer must tell you the estimated residual value of the car and the formula that will be used to determine your purchase price at the end of the lease.
Tip: If you think you might want to buy the car, be sure the purchase option is in your lease before you sign it; otherwise you'll have to renegotiate later, at which time you may have less bargaining power.
Renewal Option. You should negotiate the right to extend or renew as part of your lease. Sometimes the lessor will reduce your cost if he knows you might want an extension of the contract.
Early Termination Option. If you terminate your lease after, say, 36 months on a 48-month lease, you will have to pay an extra charge, based on the difference between the residual value of the car at that time and the estimated residual value at the end of the lease term (stated in the contract). The difference between these two may be great. In most lease agreements you must keep the car at least 12 months.
The CLA requires that the dealer tell you before you sign the contract whether you can terminate early, and the cost of early termination.
Tip: Look for a premature termination clause, which provides for termination prior to the end of the lease term.
Here is a list of questions you may want to ask the dealer before you enter into a car lease:
- What kinds of leases are available and what are the differences? The two main types of leases have already been explained here, but dealers may have variations.)
- What will my initial costs of leasing be?
- What will my continuing costs of leasing be?
- Will a trade-in decrease my initial cost or continuing costs?
- What happens if I exceed the mileage limit specified in my lease?
- How will my mileage allowance be enforced if I take an early termination or a purchase option?
- Can I sublease if I fall behind in my payments or want to stop leasing?
- What happens if I want to terminate my lease before the agreement is up?
- What are my options at the end of my lease?
- What costs and charges can I expect to pay at the end of the lease?
There are a number of other factors that come into play in the lease-vs.-buy analysis:
- When you buy a car, every monthly payment increases your equity. You'll end up with a car (of depreciated value) you can either sell or keep. In leasing you get no equity; the monthly payment is more like paying rent. You don't own the car at the end of the lease, though you may have the option to buy if that is included in your lease agreement.
Tip: With leasing, you can invest the money you would have used for the down payment. If you use the car for business, whether you lease or buy, you can deduct some or all of the cost of the car subject to current IRS rules.
- Because they aren't considered "debt", leasing contracts typically aren't listed on a loan application; leaving your credit free for other loans.
- Leasing a car is convenient and frees up cash you wouldn't have available if you bought a car, since the initial costs can be lower.
- Auto Advice provides inside secrets, tips and facts about auto buying and leasing, invoice price, rebates and trade-in tips as well as how to save money on financing, insurance, warranties and much more.
- Buying and Leasing a Car includes insider tips and new car information.
- Buying and Selling a Car provides new and used car pricing, reviews, buying & selling information.
- Car Purchasing Information provided by AutoByTel.com.
- Edmund's provides comprehensive information on entire leasing process.
- Free Quotes enables you to receive quotes from several companies by completing one quote form.
- Independent Car Ratings, detailed buying advice, and a comparison of buying vs. leasing is offered by Consumer Reports Online.
- Kelley Blue Book provides a variety of information about automobiles.
- MSN's CarPoint offers prices and previews, new car reviews, Kelly blue book values and virtual auto shows.
Car Insurance: 10 Cost-Cutters To Save You Money
The amount of money you spend for car insurance can vary dramatically depending on the insurance company you choose, the coverage you want and the kind of car you drive. Are you spending more than you need to on insurance premiums? This Financial Guide will help you get the most for your car insurance dollar.
All that is required to cut car insurance costs is a little of your time. Here are 10 cost-cutting suggestions for lowering your auto insurance costs.
Do not assume that all insurance companies charge the same rates. There are several thousand different auto insurers in competition. You can save from 30 to 50% just by comparing costs. Costs are usually based on factors such as the age, gender, and driving record of the vehicle's driver's; the state of residence; the age and value of the vehicle; and the frequency and purpose of the vehicle's use.
First, contact the insurance regulating body in your state and find out whether they provide a free pamphlet that ranks insurers by price. Many state insurance departments do this. Obtaining this pamphlet will save you a lot of time on the phone asking for price quotes. If no pamphlet is available, get quotes from independent agents (those who represent several insurance companies) and from "direct writers." Direct writers sell directly to the public and not through agents. You may save about 10% because you are not covering an agent's commission.
When calling an insurance company, ask if the insurer is a mutual company, one owned by its policyholders. If so, ask what percentage of its premiums are returned to policyholders. You may find, for example, that one company's premiums are higher than those of some other companies, but that it pays annual dividends of 18 to 20% to policyholders, which reduce your insurance costs.
In addition to asking insurance agents and insurance companies, be sure to ask colleagues and friends about their carriers. You might also look on the Internet, look in the yellow pages, check with your state insurance department, and review consumer guides.
Planning Aid: For independent advice on how to shop for car insurance and which companies offer lower rates, see Consumer Reports Online.
It is important not to neglect factors other than price. Although quality personal service may cost a bit more, it provides added conveniences, so talk to a number of insurers to get a feel for the quality of their service. Ask them how you can lower your costs.
Tip: Be sure to check the financial ratings of carriers. Check them out in ratings services, such as Moody's, and then supplement your review by calling your state insurance department for further information. Some state agencies will supply you with the number of justified complaints that have been made about insurers.
Note: In some states, car owners with good driving records cannot be turned away by the insurance company of their choice. On the other hand, an insurance company can deny you coverage-or charge you substantial premiums-if you have a poor driving record.
Although certain minimum coverages are mandatory in most states, the amounts of such coverage vary among policies. Most coverages are discretionary. Therefore, you should choose your coverage carefully to avoid being over insured, resulting in unnecessary premium costs. For those who are not familiar with auto insurance policies, all drivers are required to have the following basic coverages:
- Liability covers physical injuries to other people, including compensation for expenses that might arise from such injuries, and damage to other people's property.
- Comprehensive and collision covers damage to your car due to collision or overturning, fire, flooding, or theft (there is usually a deductible).
- Uninsured (or underinsured) motorist covers the expenses of an accident if the other driver has insufficient insurance.
- Medical protects you against medical costs for injuries to you and other riders in the car.
Note: In certain states with "no-fault" insurance laws, personal insurance protection coverage is required and there are some restrictions on liability lawsuits.
Your policy will show the total amounts of bodily injury, liability, and property damage coverage. For instance, a policy of $25/$50/$20 means that, in a single accident, you are covered for $25,000 for an individual injured, $50,000 for all persons injured, and $20,000 of property damage.
The amount of coverage you choose will depend on the state's minimum requirements, the replacement cost of your vehicle, and how much medical coverage you already have under other policies.
It may pay to absorb the cost of fender-benders yourself. In other words, get the highest deductible you can afford. If you absorb the cost of small claims and the insurance company covers the large ones, it makes a huge difference in your premium. For example, raising your deductible from $100 to $500 will reduce your premiums by 10% to 20% and raising it to $1,000 will save 25% to 30%.
Tip: Do not file a claim for a minor accident. If the damage costs a couple of hundred dollars in repairs, pay for it yourself. The expense will be more than offset by the rise in your insurance rates that will occur when you file a claim.
You may wish to drop collision and/or comprehensive coverage on older cars. (Collision coverage takes care of the cost of repairing your car if you are in an accident, regardless of who's at fault; comprehensive pays if your car is stolen or damaged by fire, flood, hail or wind.) If your car is not worth much, why pay a premium for repairs on a vehicle you will probably replace if it's badly damaged? Collision damage for an older car can cost more than the car is worth.
Tip: Drop collision if your car is worth less than $2,000 or if your premium is equal to 10% or more of the value of your car. But remember that you generally can't drop collision until your auto loan is paid off.
Tip: Check the value of your old car in the "National Automobile Dealers Association Official Used Car Guide," known as "The Blue Book" (auto dealers, banks and libraries have copies) or on the Internet, a faster, more efficient procedure.
Before you buy a new or used car, check into insurance costs. Cars that are expensive to repair or that are favorite targets for thieves have much higher insurance costs.
Not surprisingly, the more expensive the car, the more expensive the insurance. Cars that thieves love-Porsches, Jaguars, BMWs and sports models in general-are more costly to insure. The latest study shows that it costs three to four times as much to insure a Porsche as a Ford. If you buy a used car, insurance will be significantly lower.
Related Guide: Please see the Financial Guide YOUR NEXT CAR: Should You Buy Or Lease?
Tip: Call your insurance company or agent before buying a car and ask about the costs for several different models.
If you have an adequate comprehensive health insurance plan, you should consider dropping the of medical expense coverage from your auto insurance policy. This could lower your premium by up to 40%.
Most insurance companies will reduce premiums 10% to 20% for some or all of these situations. However, you may have to bring up the subject with your agent.
- Automatic seat belts and air bags
- Anti-lock brakes
- Insuring more than one car
- No accidents in three years
- No accidents ever
- Drivers over 50 years of age
- Driver training courses
- Anti-theft devices
- Good grades for students
- Low mileage discounts
- Insuring your home or apartment with the same company
- College student living at least 100 miles away from home without a car on campus
- Not smoking
- Not drinking
- Serving in the armed forces (past or present)
- Car pooling
- Ignition cutoff system and/or a hood or wheel-locking device
- Being a doctor, lawyer, farmer, or member of a profession that the insurance company regards as a good risk
- Being female and the only driver in the household
- Renewing for longer than a year
Here are some tips for making sure that you obtain a fair settlement and obtain payment on a claim as quickly as possible.
Start a file on the accident immediately. Put into it hospital bills, police accident reports, and copies of claims you have submitted.
Where practical, write a follow up letter summarizing any phone conversations with an insurance company representative. Include the date of the conversation and the name of the person spoken to. Put a copy of the letter in the file.
If it is taking a long time to obtain your settlement, check your policy to see whether interim rental car expenses are covered. If so, rent a car. The insurer will be motivated to speed things along to avoid incurring this cost.
If you feel the company is being unreasonable-is delaying or not acting in good faith-make a complaint to your state's insurance regulator.
If you are getting nowhere, and the claim is substantial, consider consulting an attorney.
The Direct Repair Program, or DRP, is a type of "managed care" approach to getting your car repaired, available from many major insurers. The idea behind DRP's is that they will save insurers money by cutting car rental periods for loaners, by eliminating the need for adjusters and by taking advantage of discounts on parts and labor. Some of these savings should be passed on to you. In some cases, insurers have been known to take up to 20% off premiums for collision/damage coverage.
Whether most people will save much with a DRP is unclear. However, if you have a busy schedule, the DRP's advantage is that it will certainly save you time. In addition, it can take the stress out of filing a claim.
Tip: Insurers seldom advertise their DRP's, so you will have to ask. Then get a list of repair shops near you. Skip the plan if you have to travel too far to an approved garage.
The DRP plan lets you choose between using a prescreened network of repair shops or your own mechanic. The repair shops participating in the network have already negotiated agreements with the insurance company. Use one of them and the insurance company will cover all costs except the deductible. Without this program, the old rules apply: you get the best estimate and then hope your insurer will pay.
The great advantage is that you do not have to shop for estimates because the garage is authorized by the insurer to do the repairs. Some even loan you a car while repairs are being done. And, because you do not have to wait for a claims adjuster, you will probably get your car back sooner. Sometimes the garage or the insurer also guarantees the repairs for as long as you own the car.
Before signing up for a DRP, get answers to these questions:
- Will I get a break on my premiums or a lower deductible on collision?
- Are eligible repair shops nearby?
- What if I have an accident while traveling out of state?
- For how long is the repair work guaranteed?
- Will I get a free loaner while repairs are done?
Finally, at the risk of being obvious, drive carefully. Accidents can greatly increase your premiums as well as cause the insurance company to refuse to renew (or, in serious cases, to cancel) your policy. And don't forget to take your car key when leaving your car: a car is stolen every 19 seconds in the U.S. and over 20% have the key in the ignition.
When calling insurers to request price quotes, this checklist of information will come in handy.
|Vehicle ID No.||______________________|
|City/State/Zip For Car's Location||______________________|
|Total miles driven per year||______________________|
|Miles driving to & from work||______________________|
|Miles driving to & from school||______________________|
|Miles driving for business||______________________|
|Miles driving for farming||______________________|
|Driver Information (for each driver to be insured) |
|Relationship to Applicant||______________________|
|Date of Birth||______________________|
|Moving violation convictions in past three (3) years (be ready with details).||______________________|
|Accidents in past three (3) years.||______________________|
For free brochures on buying and insuring cars, contact:
The Insurance Information Institute
110 William Street
New York, NY 10038