April 2008
Comparing auto-financing options
How to decide whether a loan or a lease is more economical for you
It's up there with baseball vs. football and creamy vs. crunchy. Which is better: financing or leasing a new car? Leasing
is often touted as the option that gives you "more car for less money." This month, the Consumer Reports Money Lab set out
to test that premise.
The more car/less money argument resonates with a lot of car shoppers. Leasing accounted for nearly 27 percent of all new vehicle acquisitions in 2007, according to CNW Marketing Research. Part of what's making the option more tempting: The average monthly lease payment has dropped 44 percent in the past five years. In the auto section of the newspaper, dealers promote low monthly payments in large type. Buried in the small print, however, are all the fees that can boost your overall cost.
Tools of the trade
Numerous online tools are available to help you make the buy-or-lease decision. You can find questionnaires and calculator on the Web sites of auto dealers, financial institutions, and other parties. The questionnaires or "recommenders" usually consist of six to eight questions about your finances, driving habits, and preferences. Your answers are evaluated, and a lease-or-buy recommendation spews forth.
With a calculator, you'll typically type in such variables as the cost of the car, your down payment, the term of the lease or loan, and other numbers that will get crunched to determine which deal will be the most financially advantageous for you. Unfortunately, the calculators often don't ask for important data such as acquisition fees, insurance costs, "drive-off" fees, and any up-front state sales taxes. And even if they took those costs into account, you might not have them at hand. Some calculators will estimate them for you, but one of the most important values in the equation, the car's residual value at the end of the lease, can vary considerably from one leasing company to the next.
The questionnaires and calculators have their place. Indeed, this site offers a number of financial calculators in the Cars
section. However imprecise, a calculator will at least let you know if you're in the right ballpark to lease or buy the model
you have in mind. Of course, there is also a subjective factor to driving—an activity that occupies the average American for
15 hours a week—and even the most sophisticated calculator won't be able to measure just how much it's worth to you to be
in the vehicle you want for those 15 hours.
The cold, hard facts
We won't keep you in suspense: The Money Lab determined that buying a car—in this case, the best-selling 2008 Honda Accord EX, at $24,495—would cost $4,597 less over five years than closed-end leasing for exactly the same model.
We compared the two most common arrangements: a three-year lease and a five-year loan, and analyzed total costs after each year over five years. Since the lease is up after only three, we assumed that the lessor took out a new lease-same terms, same vehicle, only newer-in the fourth year. Specifically, we took Honda's February 2008 online lease offer of 36 monthly payments of $239 and put it up against a typical five-year loan at 6.99 percent, which is the rate a buyer with good credit could expect to get. For comparison, we also did the same exercise with a more expensive model, the 2008 Lexus ES 350, which sells for $38,405 and can be leased for $429 a month.
If you look merely at the monthly costs, leasing seems like the better deal for both cars. But the advantage changes over time, as the totals in our comparisons show. Further, our calculations don't include the equity building in the financed car (but do show the impact of depreciation for both).
Also consider that after three years, the financing buyer will still have a car to drive, while the lessor must return it and start all over. He or she will have to lease another car and fork over a new set of up-front payments or else finance a car, buy one for cash, or bone up on the local bus routes. Our test assumes the lessee enters into a new lease agreement.
And don't forget the end-of-lease costs
Our calculations don't take into account end-of-lease costs. For example, excess mileage charges (15 cents per mile in the case of the Accord) can quickly add up. Data from CNW show that 35 percent of leases with an annual 12,000-mile limit are exceeded, with the average being 2,500 miles. Wear-and-tear assessments averaged $1,700 in 2006. (Not surprisingly, wear-and-tear charges might sometimes be overlooked by a dealership if you lease another car.) CNW also found that excess mileage and excess wear charges account for the bulk of lease dissatisfaction. What's more, a leased car might be more expensive to insure.
Finally, consider that the Federal Reserve cut short-term interest rates 1.25 percent in January 2008 alone. The lower rates are already working their way into the auto-loan market, where rates were trending down in early February after spiking at the start of the year. Consequently, the difference between the monthly payment of a leased car and a financed one should narrow considerably.
The more car/less money argument resonates with a lot of car shoppers. Leasing accounted for nearly 27 percent of all new vehicle acquisitions in 2007, according to CNW Marketing Research. Part of what's making the option more tempting: The average monthly lease payment has dropped 44 percent in the past five years. In the auto section of the newspaper, dealers promote low monthly payments in large type. Buried in the small print, however, are all the fees that can boost your overall cost.
Tools of the trade
Numerous online tools are available to help you make the buy-or-lease decision. You can find questionnaires and calculator on the Web sites of auto dealers, financial institutions, and other parties. The questionnaires or "recommenders" usually consist of six to eight questions about your finances, driving habits, and preferences. Your answers are evaluated, and a lease-or-buy recommendation spews forth.
With a calculator, you'll typically type in such variables as the cost of the car, your down payment, the term of the lease or loan, and other numbers that will get crunched to determine which deal will be the most financially advantageous for you. Unfortunately, the calculators often don't ask for important data such as acquisition fees, insurance costs, "drive-off" fees, and any up-front state sales taxes. And even if they took those costs into account, you might not have them at hand. Some calculators will estimate them for you, but one of the most important values in the equation, the car's residual value at the end of the lease, can vary considerably from one leasing company to the next.
Cash and carry
There is another option, of course. You can pay cash for the car. You'll owe no finance charges, and you're free to drive as many miles as your gas budget allows. But given that an average new car will cost you about $25,000, scraping up the cash might not be so simple. And putting your money into an asset that depreciates by thousands of dollars as soon as you start using it might give you pause.
Even if you can haggle a discount for paying cash (which may not be much, since dealers profit from the car's financing as well as its sale), there's still the matter of what you could have earned elsewhere. Though interest rates are heading lower, you could still get a multiyear CD earning 3.4 percent in late January. Putting most of the $24,495 you'd spend on a new Accord to work for you (after setting some aside to use for car-loan payments), earns you about $1,300 in interest, before taxes, over three years. Of course, you'll pay more than that in interest on a car loan, unless you have low or zero-percent financing. In our example, financing the Accord at 6.99 percent over five years costs $3,800 in interest for the first three years.
If that $24,495 seems a bit steep to shell out but you still want the peace of mind of not owing a car payment every month, consider paying cash for a late-model used car, which has already taken its depreciation hit.
The cold, hard facts
We won't keep you in suspense: The Money Lab determined that buying a car—in this case, the best-selling 2008 Honda Accord EX, at $24,495—would cost $4,597 less over five years than closed-end leasing for exactly the same model.
We compared the two most common arrangements: a three-year lease and a five-year loan, and analyzed total costs after each year over five years. Since the lease is up after only three, we assumed that the lessor took out a new lease-same terms, same vehicle, only newer-in the fourth year. Specifically, we took Honda's February 2008 online lease offer of 36 monthly payments of $239 and put it up against a typical five-year loan at 6.99 percent, which is the rate a buyer with good credit could expect to get. For comparison, we also did the same exercise with a more expensive model, the 2008 Lexus ES 350, which sells for $38,405 and can be leased for $429 a month.
If you look merely at the monthly costs, leasing seems like the better deal for both cars. But the advantage changes over time, as the totals in our comparisons show. Further, our calculations don't include the equity building in the financed car (but do show the impact of depreciation for both).
Also consider that after three years, the financing buyer will still have a car to drive, while the lessor must return it and start all over. He or she will have to lease another car and fork over a new set of up-front payments or else finance a car, buy one for cash, or bone up on the local bus routes. Our test assumes the lessee enters into a new lease agreement.
And don't forget the end-of-lease costs
Our calculations don't take into account end-of-lease costs. For example, excess mileage charges (15 cents per mile in the case of the Accord) can quickly add up. Data from CNW show that 35 percent of leases with an annual 12,000-mile limit are exceeded, with the average being 2,500 miles. Wear-and-tear assessments averaged $1,700 in 2006. (Not surprisingly, wear-and-tear charges might sometimes be overlooked by a dealership if you lease another car.) CNW also found that excess mileage and excess wear charges account for the bulk of lease dissatisfaction. What's more, a leased car might be more expensive to insure.
Finally, consider that the Federal Reserve cut short-term interest rates 1.25 percent in January 2008 alone. The lower rates are already working their way into the auto-loan market, where rates were trending down in early February after spiking at the start of the year. Consequently, the difference between the monthly payment of a leased car and a financed one should narrow considerably.
