From the mailbag: Car Talk

No, leasing your car is not financially sensible

A correspondent asks:

My crazy uncle swears that leasing a new car is a better deal than buying one — the lease payment is lower than a loan and I can get a new car every three years. Is he right?

Rider on the Storm

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Hi Rider-

In most circumstances, leasing a car does not make financial sense compared to buying one. Why not? Well, a car lease is carefully designed to befuddle you with complexity and hidden fees that obscure the full ownership cost.

I understand why people lease — yes, the monthly payment is lower than a loan with an equivalent term. But, that’s a false comparison. When a car loan is paid off, you own a car. When a lease is paid off, you own nothing. You may even owe additional fees for excess mileage or wear and tear. With a lease, you pay for the depreciation of the car but don’t build any equity in it.

What is a car lease? It's really a car loan with the added twists of the end-of-lease value of the car and contingent fees specified up front. The monthly cost of the lease is determined by the interplay of the purchase price, terminal value, implied interest rate, term, and down payment.

Do you know what these terms mean:

• Capitalized Cost

• Acquisition Fee

• Money Factor

• Disposition Fee

• Residual

If you don't intimately understand those terms — and you can be sure your car dealer does — then you're at a disadvantage in your car leasing negotiation.

Seems complicated? It does to me.

My favorite term is the money factor, which is a complicated way of expressing the implied interest rate in your lease (yes, you are borrowing money). To convert the money factor into your interest rate, you need to multiply it by 2,400. It sounds like Babylonian mathematics.

When you lease a car, you are almost certainly unaware of the implied borrowing cost and without knowing this interest rate, you can't compare the lease terms to a loan. Why not simply call it an interest rate and present it in an understandable fashion? The question answers itself.

When you see a transaction with this level of complexity, that's your tell that you're outgunned and should proceed at your financial peril. You're facing an information asymmetry where the dealer knows much more about this complex transaction than you do. As with other complicated financial products such as variable annuities and whole life insurance, these situations don’t end well for the consumer.

If the car loan payment is unaffordable, then that’s your signal that the car is too expensive for you — leasing doesn’t change those economics.

So, if your crazy uncle is telling you to lease your next car, move on to his next tip. You'll end up paying more than if you simply purchased the car with or without a loan.