The next time you see a car commercial watch a little more closely. You will likely notice that the advertiser lists the lease price of the car at the end. This is because the car lease is the best financial deal…for the car dealership. Many buyers may not know that car dealerships actually make very little profit when a buyer comes in and writes a check for a car. In most cases, the money is made on leases, financing, and maintenance. The car lease can be a financially devastating decision. Particularly for those of us who are trying to build wealth and gain financial independence (this should be everyone!). Let’s explain why.
First, we have to pick a car to lease. A number of stories have been written about millennials leasing luxury cars at a rate unseen in any other generation. I’m feeling a bit fancy today so let’s go with the 2016 Mercedes Benz C300 4MATIC® Sport Sedan. The listed MSRP for the car is $40,950. I’m in no position to lump down 40K for a car, so how about a lease? Eureka! I can lease the car for $389 per month for 36 months! The car just went from out of my price range to within reach. I’m getting a deal, right? To find out we’ll continue the example. But first, let’s revisit CARS 101 for a second. A general rule is that the largest depreciation in a car’s value occurs in the first 3-5 years of ownership. In those years, the biggest loss typically occurs in the first year. So we immediately know that by signing a 3 year lease we are driving the car at what is mathematically speaking, the least cost effective time to drive any car. It's actually a pretty genius idea by the car dealers. Have people like you and I eat the depreciation and give it back to them after that to sell for a profit. Okay, back to our example.
We are ready to lease our car for $389 per month! But, there is $4,683 due at signing. So, we are essentially making a down payment that we will never see again on a car we are renting! This cost includes the first month’s lease payment. With these costs together over 36 months we will pay $18,298. Now, let’s take a second and discuss what MUST be true in a car lease. In order for a car lease to make money for the dealer (If it doesn’t make them money they aren’t going to do it) the amount the lessee pays must cover the full depreciation costs of the car AND some extra to put money in their pockets. At this point you are likely starting to see why this is bogus. But it gets worse.
As a part of the lease agreement they only allow us to drive the car for 30,000 miles over the 3 years. If we exceed that limit we will pay excessive wear and tear fees plus $0.25 per mile over 30,000 miles. According to multiple outlets (Kelley Blue Book, Carmax, Time Business) the average mileage on a car per year is 12k-15k. But, we are allotted only 10k. This means that we are either bound to exceed the mileage and encounter more fees or we are going to have to park the car we are paying an arm and a leg for and drive something else to avoid going over the mileage. No freaking Bueno! We also have to consider that at the end of our lease we will have to pay either a $595 vehicle turn-in fee or use our purchase option and buy the car for $27,169 plus taxes. Keep in mind that means we will have paid a total of $45,467 (if we didn’t exceed the mileage) not including taxes for a car whose cost brand new was 40,950. But, we will assume we return the car at the end of the lease.
Okay, let’s do some quick math.
Total Lease Payments: $389 x 35 months = $13,615.00
Cash due at signing: $4, 683.00
Cost of driving average mileage (Assuming you drive 12,000 miles per yr):
6,000 (2,000 miles over each yr) x 0.25 = $1,500.00 plus excess wear and tear fees.
Vehicle return fee: $595.00
Total cost: $20,393 plus excess wear & tear fees
Kelley Blue Book estimates the value of the car to be 22-23K after 3 yrs at the mileage rate above. That means the depreciation in the car was about $17,950.00 but we paid them $20,393.00 AND we have to give back the car so we have nothing to show for the money. THIS IS A RIP OFF!
Lastly, let’s consider the opportunity cost. Instead of flushing our money on a rip off car lease how about we spend half of that cost on a car in year 1 ($10,000). And invest $398 a month for 36 months.
Money made starting with 0 and investing $389.00 over 36 months:
If you average 10%: 16,996.19
If you average 8%: 16,366.54
Not only would we still have our car, (because we weren’t renting it) we could also have nearly $17,000 in our investment. And think, even if you invested your money and did not make a dime you would still have $14,004.00 compared to losing every cent of that money in a lease. Something to consider.