Leasing Vs Buying A Car (Pros and Cons) | How to Calculate a Car Lease Payment

Leasing Vs Buying A Car (Pros and Cons) | How to Calculate a Car Lease Payment


Well, yet another week and yet another Finance
Friday video. So as I said last week the car is the most
expensive purchase most people make that goes down in value. Now with that in mind wouldn’t it make sense
that you wouldn’t want to make a big purchase on something that is almost guaranteed to
go down in value? What if you didn’t actually buy the car at
all? Would that be better for your financial Foundation? That’s what we’re going to be talking about
today as you can see by the title of the video today we’re going to be talking about leasing
versus buying a car. Hey everyone, Daniel here and welcome to Next
Level Life a channel where you can learn about Investing, debt, retirement, and many other
general financial education videos because the school’s aren’t going to do it for us. So if any of those topics sound interesting
to you or if you want to learn how to better handle your money and have more financial
freedom be sure to hit that subscribe button and the bell next to my name to be notified
every time I upload a video. So I thought talking about this would be a
good follow-up to last week’s video on the 20, 4, 10 rule. So today I’m going to be talking about what
leasing a car is and how it differs from buying a car, some of the benefits and downsides
of both Leasing and buying. I’ll show you how a car lease payment is
calculated and then doing a bit of a mathematical comparison between the two options where I
will also tell you how Dave Ramsey says that car leases charge you an effective interest
rate of about 14% or 15%. This is going to be a bit of a longer video,
so let’s get started. So first let’s define the difference between
Leasing and buying a car. The best way that I can explain it is to say
that leasing a car is basically just renting the car. Similar to how you might decide to rent an
apartment instead of buying a house. When you lease a car the lessor or the person
holding the lease rents the car to the lessee, or you, for a specified period of time in
return for periodic payments. Now that sounds in many ways very similar
to what happens when you sign a car loan right? You got the car in return for making regular
payments to the loaner. The difference, of course, is that once you
finish paying off the car loan you own it. However, when you lease a car and the lease
term ends you trade the car in and assuming you sign another lease you get a new one. This means that at no point in time do you
actually own the car. It is never an asset for you. Whereas if you were to sign a car loan and
make payments the car would be an asset to you after the final payment is made. Now, of course, you can decide to purchase
the car that you least out right at the end of the lease, that is an option, but not a
whole lot of people do that and we’ll get to why that is later in the video. But first, let’s talk about some of the benefits
of leasing a vehicle. The first benefit that people often point
to is that under most circumstances unless you make a really big down payment when you
buy a car the monthly payment on a lease is generally going to be lower than the monthly
payment on a car loan. And again I will show you exactly why that
is when I get to the comparative example but for now, let’s just go through the benefits. The second benefit that people often pointers
that there’s no need to worry about selling your car at the end of the lease term because
when the lease term ends as I said is simply drop the car off at the dealership and either
sign a new lease or move on to some other car buying strategy. The third benefit to leasing that many people
point to is that the car often times remains covered under a warranty because the lease
terms generally don’t last more than say 3 or 4 years and sometimes they’re even shorter. And since the warranty on most cars is roughly
the same as the lease length or at least the average lease length you often times have
a more predictable total cost of car ownership. And some leases may even include basic maintenance
so if that’s the case you’re only cost would be insurance and fuel. The fourth benefit that many people going
to is the small down payment that is required for a lease. And you could argue whether or not that’s
really a benefit but we’ll get to that later in the video. But for those consumers who don’t have a lot
of money saved up for a downpayment, it often seems like a good benefit. And obviously when you’re leasing cars every
few years you always have access to at least nearly the latest technology if not the latest
technology goes your car is new. And for many, this is a huge benefit. The last benefit that people often point to
when it comes to leasing versus buying a car is the potential tax savings that you may
experience. Although you’ll definitely want to check with
a tax professional to find out how leased vehicles are taxed in your area because it
does vary from place to place so that may be a benefit and may not be a benefit depending
on your situation. The downsides to leasing a car are of course
the rules and restrictions that seem to pop up all over the place. Depending on your lease you may have mileage
restrictions, excess wear-and-tear fees, ride-sharing restrictions, the need to have excellent credit,
and possibly even the need to purchase gap insurance. Typically you will have mileage restrictions
on leases between 9,000 and 15,000 miles per year and if you go over that you get charged
a pretty hefty excess mileage fee which can range from $0.20 a mile to a $0.25 a mile
or maybe, even more, depending on what it says in your lease. Now of course I’m told from people who have
leased cars that they don’t generally check the amount of Miles you’ve driven each year
but rather if it’s say a 3-year lease and you have 15,000 miles per year that you’re
allowed to drive they will check it at the end of the lease and see if you went over
45,000 miles and if you did they will charge you for the extra miles at that point. I have not ever released a car so I have to
go with what I’ve heard from people who have and that’s what they’ve said. As far as the excess wear-and-tear fees go
I’m told that some wear and tear is to be expected you won’t be charged for every minute
thing but you are expected to return the car in nearly its original condition and any customization
that you have put on the car needs to be easily removable. And in some places you’ll also have to be
able to show that all recommended Services were performed on the car at the proper times
so I imagine there is quite a bit more paperwork with this route as opposed to buying a car,
which may matter for some but for some others it may be worth it. I’ve also been told that with very few exceptions
you need to have top-notch credit scores to be able to lease a car and leasing companies
almost across the board require you to purchase gap insurance. And of course the last downsides to leasing
a car is that some leases will have early trade-in fees or penalties and you never hold
any equity in the vehicle when you return it at the end of the lease contract you will
have nothing to use as a down payment on your next vehicle unless you were diligent and
saved up during the time that you had the lease. And obviously, when you’re buying a car the
benefits and downsides are flipped. When you buy a car you don’t have any monthly
payments after the loan is paid off you don’t have mileage restrictions or any customization
or excess wear-and-tear fees and your credit does not have to be excellent although it
would certainly help when it comes to interest rates on a loan. However it is generally more expensive in
the short-term month-to-month then leasing is, some dealers will try and talk you into
a long-term loan since it makes the monthly payment look smaller but it usually carries
a higher interest rates and of course keeps you in debt longer which is generally not
a good thing, and you may need a pretty hefty down payment depending on your situation. So how do you calculate a monthly lease payment? This is one thing that I wasn’t going to do
initially in this video but decided that I should do it because I couldn’t find too much
information about this in other videos on YouTube. First, you’ll need a few things. You’ll need the MSRP of the vehicle also known
as the sticker price of the vehicle. Next, you’ll need the money factor which is
also sometimes called the lease factor or even a lease fee and you’ll usually need to
call the dealership that you’re looking to lease the car from in order to get this. They will likely ask you what brand make and
model you’re considering leasing so be sure to have that information ready when you call. Third, you’ll need the term or length of the
lease most sites that I researched recommend leasing for no more than 36 months but there
are some specials for 39 months. But the point is you need to know how long
your lease term is going to be. Once you have that you’ll want to find the
residual value of the car by asking the dealer what the residual percentage is for the specific
car that you’re considering while you’re on the phone with them. The residual percentage varies of course between
dealers in cars but it’s usually somewhere in the neighborhood of 45% to 60% for a 36-month
lease. You also need to find out if there are any
fees associated with the lease. Common fees include registration fees, acquisition
fees, and sometimes down payment tax but there may be others. And the last thing you’ll need is any rebates
that are available to you if you have any. Once you have all that information here’s
how you calculate your monthly lease payment. For this example let’s say that John is going
to lease a car with an MSRP of $25,000. To keep the math simple will say the residual
percentage is 50% and the money factor or the least Factor will be 0.00125. He’s Leasing and will not make any down payments
on the car and he does not have any rebates, but he does have $1,200 in various fees and
has a lease term of 36 months. Once you have all that information here’s
how you calculate your monthly lease payment. The first step is to take your vehicle’s MSRP
and multiply it by whatever the residual value is that you are given. In John’s case, that means he takes $25,000
* 50%. This gives him a residual value of $12,500
for his leased car. We’re going to assume for the sake of this
example that he did not negotiate the actual sale price on a car and instead just purchased
it for the sticker price or MSRP. Therefore Step 2 is to take the sale price
and add in any of the fees that you have to pay in order to get what the car manufacturers
called the gross capitalized cost. In this case, since he didn’t negotiate, he
paid the MSRP of $25,000 and had $1,200 in fees. Therefore his gross capitalized costs are
$26,200. Step 3 is to take any down payment, trade-in
equity, or rebates that you might have an add them together in order to get what they
call your capitalized cost reduction. In John’s example, he didn’t make any down
payments and he didn’t have any trade-in Equity or rebates so his capitalized cost reduction
is just going to be zero. Step four is to take the gross capitalized
cost that you figured out in Step 2 and subtract the capitalized cost reduction you just figured
out in step three in order to get your adjusted capitalized cost. again in John’s case, he didn’t have anything
in step three so is adjusted capitalized costs are the exact same as gross capitalized costs
cost of $26,200. Step 5 is to take the adjusted capitalized
cost you figure it out and step 4 and subtract the residual value that you figured out and
step one in order to get what they call you or depreciation amount. In John’s case, his adjusted capitalized costs
were $26,200 and his residual value was $12,500. So punching those into the calculator you
find that his depreciation amount for the car lease will be $13,700. This number is very important because it’s
what your base monthly lease payment is going to be calculated with. And that’s what we do in Step 6 you take the
depreciation amount you figured out and step five and divide it by however many months
you are leasing goes for. In John’s case, he had a 36-month lease so
he takes $13,700 and divides it by 36 which gives him a base monthly payment of about
$380 a month. But don’t get excited we’re not quite done
figuring out your actual monthly payment yet there still a few more steps. In Step 7 you take the adjusted capitalized
cost that you figured out and step for and add the residual value that you figured out
in Step 1 and then you multiply that number by the money factor. So in John’s case, he had an adjusted capitalized
cost of $26,200 and a residual value of $12,500. So we add those and that gives us $38,700.
we then take that $38,700 and multiply it by the money factor of 0.00125 which gives
us a little over $48 a month. This number is what the leasing companies
called the rent charge. Step eight is where you at that rent charge
to the base payment that you calculated in Step six to get your pre-tax lease payment. In John’s case, this means he takes the $380.56
that he calculated In Step 6 and adds the $48.38 from Step 7 to get a pre-tax monthly
lease payment of $428.94. Now if you’re lucky enough to live in a state
that doesn’t charge sales tax you’re done calculating your lease payment. However, if you’re like most of us that live
in a place that does charge sales tax then you need to multiply that pre-tax monthly
lease payment by the local sales tax rate where you live to get your total monthly lease
payment. Let’s say John lives in Santa Monica California
just for the sake of this example they have a sales tax of about nine and a half percent. Meaning that he would have to take that pre-tax
monthly lease payment of $428.94 and multiply it by 1.095 to get his monthly total monthly
lease payment of $469.69. So that’s how you calculate a lease payment. Now I know that many of my viewers also watch
Dave Ramsey and so you’ve probably heard him say that leasing a vehicle is the most
expensive way to own a car. He says that on average the effective interest
rate on car leases are about 14%-15% which is about as high as the average interest on
credit cards. So this is kind of a big deal. But one thing that I haven’t heard him talk
about before is how the people calculating that effective interest rate arrives at 14%
or 15% because you certainly don’t see anything on the lease contract that says you’re paying
15% interest on this lease. You see what the money factor is but that’s
about it. Well here’s how you calculate it. When John was paying for that lease on his
$25,000 MSRP car, the base monthly payments weren’t actually being calculated based
off of $25,000 like they would be on a normal car loan were they? No, they were being calculated based off of
the difference between the cost of buying the car (after things like registration fees
were taking into account) and what the residual value of the car will be at the end of the
lease term, which is obviously estimated by the leasing company prior to you signing the
lease. In the example with John, the difference between
those two numbers was $13,700. So let’s say that for example instead of
leasing a car, he decided to buy a car for the same $13,700 that his base monthly lease
payments were being calculated with. And let’s also say that the $13,700 car
loan that he signed when he bought the car was for 36 months and his monthly payments
were just under $470, just like they ended up being for his lease. If you punch those numbers into a loan calculator
and ask it to find you the interest rate on the loan, you’ll see that it comes out to
be about 14.2%. And just for grins and giggles do you want
to know how much you would be paying a month if you bought a $25,000 car instead of leasing
it? Well assuming we go with the averages, the
average interest rate on a new car loan according to Experian is a little under 4.5%, so I’ll
use that for the interest rate and I’ll say it’s a 60-month car loan. The monthly payment?… $466.08. So not all that much different than the lease,
except for the fact that you may have some resale value at the end of the car’s run
that you can then use for a downpayment on the next one. So as you can probably tell, I personally
am in favor of buying a car as opposed to leasing it, but that doesn’t mean that my
opinion is objectively and universally the correct one. For some people, it may be worth taking on
that higher effective interest rate in order to always be driving with the latest technology
and not having to go through the hassle of selling the car at the end of its run. And that’s perfectly fine, my goal with
this channel is not to tell you what to do with your money. My goal is just to make sure you are aware
of what options are out there and do my best to clear up any mysteries in the realm of
personal finance. But that’ll do it for me today once again
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