The article below has been contributed by an experienced executive in check guarantee industry. It is a great article worth reading for businesses and consumers.

Should You Lease or Buy a Car?

In 2017 about one third of all new vehicle sales will be done with a lease, making leasing a very important part of the dealer business model, and the consumer experience too.  Most people think that leases are a relatively recent development, but it turns out that in the United States leases of horses and wagons by livery stables began way back in the 1700s, and by the 1870s leasing was widespread for the railroad industry rolling stock.  After WW II, automotive leasing became a mainstream business, and in 1954 U.S. Leasing Corporation became the first company formed to specifically lease general equipment.  Early leases were net leases, meaning that the lessee paid all the expenses of maintenance, insurance, and taxes.

The modern auto lease was invented by Eustace Wolfington, in the early 1960’s.  At that time, finance companies only dealt with business clients, not directly with consumers.  Wolfington’s idea was to get the consumer to move from a 4-year car loan to a 2-year lease, which would enable him to sell more cars, because the consumer would be coming back twice as often!  To accomplish this, he had to reduce the cost of financing a new car.  His equation was to have the consumer finance or lease only half of the car’s price, which was a pretty brilliant idea.  After two years, the dealer would take the car back and resell it.  The trick was to predict the residual value pretty close to the actual market value in two years.  Lenders were skeptical that the resale value two years later could be predicted accurately.  To make it work, he had to get institutional lenders to lend on a non-recourse basis.  Ultimately, he signed up over fifty banks for the program, and published the first leasing guide.  He also created the first lease renewal program when he found that consumers would return the car at the end of the lease, and then go away and buy a new car from another dealer.  From 1965-1968, fleet registrations averaged only about 774,000 vehicles each model year, and leasing had not yet gained traction beyond the rental car industry.  But his concepts were ultimately adopted by the Ford Motor Co. in the 1980s and formed the basis of the current lease model.

As an aside, here is an example about the importance of predicting residual value.  When the Cadillac Allante came out, Cadillac announced in late 1986 that it would peg the residual value calculation to the depreciation of the Mercedes 560 SL, its theoretical competitor.  Guess what happened? Allante’s resale value dropped like a stone, while the Mercedes value held steady.  Cadillac lost as much as $14,000 per car on this promise, which they reneged on in September 1991.  This engendered class action lawsuits and created a whole class of people who said they would never buy a Cadillac again.  It turns out that predicting the future is difficult.

In this short article, we want to explore two questions: how does the consumer determine whether to lease or buy, and how do dealers make money on leasing?

To get straight to the point, there is no absolute rule, because each consumer has different needs, some financial, and some emotional.  Let’s compare what goes into the equation.

When you BUY a car, you may not have to make a down payment, depending on your credit score.  This has changed the most basic assumption here, because for years it was that if you bought a car you had to write a big down payment check, and if you leased you only had to write a small check, called a “drive-away fee.”  For the last few years, anyone with a good credit score did not have to make a down payment, so this logic went out the window.  Moreover, the price of the average new car has gone from $27,000 to $35,000 in a short period of time, which also changes the equation.  Traditionally, your monthly payment will be usually lower for a lease (although now we are seeing 6 and 7 year loans, so people can qualify for the bank loan, and this has the effect of lowering the monthly payment).  Ultimately, if you pay off the loan, you can sell the car and depending on condition, mileage, and resale value, the net cost may be surprisingly affordable, if you choose the right car (i.e. a popular model) and keep it for a long time.  You retain the freedom to sell it whenever you want.  But you should be aware that the value will depreciate as much as twenty percent the day you drive it off the dealer’s lot!

When you LEASE a car, you will have a large big amount due at signing, often a few thousand dollars.  You will have to keep the car unmarked, because you will be charged for every little scratch and ding when you return it.  If you rack up excess miles beyond the contract amount, you will find that leasing can be very expensive!  This is because a lease typically allows only about 10,000-12,000 miles a year, and mileage after that is billed at fifteen cents a mile, or more.  A lease contract is difficult, well almost impossible to break.  The monthly payment will typically be less than buying, so you can lease a more expensive car.  If you have a small business and the business leases it for you, they can deduct the full cost of the lease as a business expense if you use it in the business.  Leasing normally includes all maintenance, but because new cars typically have a warranty period that exceeds the lease period, this is not such a big deal.  Every new car today has a three-year bumper to bumper warranty anyway.  You might have to pay for oil changes, but tires will last 50,000 miles, well beyond the lease period.  The traditional wisdom is that because leasing costs less up front, you can drive more car than you can afford, and you can upgrade to the latest model every two years!  If you live in Beverly Hills, this might be an important consideration.

There is actually a third option, which is what is called LEASE TO BUY.  Here, at the end of the lease you can buy the car based on the residual value, or what the dealer estimates he can sell it for.  If you really like the car and have taken good care of it, this might be a good option, particularly if you can buy it at a discount because the dealer does not want to have to recondition it and remarket it.

You can do the numbers yourself to determine what the costs will be for each option.  We will compare two three-year leases with a five-year car loan.  First compare the down payment on a purchase to the “drive-off fee” of the lease.  Next, compare the monthly fee for a five-year car loan to that of a three-year lease, and add up the totals for this period (the sixth year will be free for the purchased car).  When you add up the down payment and the total of the monthly payments for six years (two three-year leases), it will appear that leasing is cheaper.  However, when you end the lease, you have no equity in the car.  When you pay off the bank loan, you have whatever equity is left, which on a six-year-old car is a substantial number. Just for the record, the average car on the road today is eleven years old.  When you add back that equity, it is definitely cheaper to buy than to lease.  Of course, buying a used car would be even cheaper.

Dealers will generally make more money doing a lease than a straight sale.  For one thing, consumers are confused or intimidated by all the terms involved: such as “money factor,” “capitalized cost reduction,” “residual,” “acquisition fees,” etc.  Consumers are accustomed to negotiate with the dealer when they buy a car, but when they lease they are told that this is the price set by the leasing company and there is no negotiation.  So, consumers focus on the monthly payment, not the overall price.  This is not true; Of course you can negotiate price and payments, but most consumers will not do so for a lease, so that is a big difference right there.  There are more ways for the dealer to make money with leasing.  For one thing, when the dealer does the lease with the financing source, the actual selling price of the car is not separately disclosed in the lease contract – it is included in the “gross capitalized cost,” a number which includes other items too.  This makes it difficult, if not impossible, for the consumer to know what they actually paid for the vehicle!  (To convert the “money factor,” just multiply it by 2400.  For example, a factor of .00375 is a 9% interest rate).  If the dealer makes a 3% markup on your financing, they can make a profit of more than $1,500 right there. The dealer can pick and choose from leasing companies, and can choose one which will finance the full MSRP of the car, so they can add high margin items such as paint protection and other relatively useless add-ons.  On a three-year lease, just adding $31 to the monthly payment doesn’t seem like a lot, but over three years it equals $1116!

With a lease, there is no interest rate as with a loan.  The lease has what is called a “money factor” set by the lender that is applied to the “lease capitalized cost.”  The dealer can mark up the money factor and get money back from the leasing company, the difference between the “buy rate” and what the dealer sells it for.  It is almost impossible for the consumer to determine what the actual interest rate is.

The dealer usually finds it easier to add more products or services to a lease.  Gap insurance is usually mandatory for a lease and the dealer makes a profit on this.  Other services can be added and it is difficult for the consumer to determine the actual cost because it is bundled in the lease rate.

In conclusion, whether it is leasing or buying, the important thing to remember is to do your research and understand all the terms of the contract, and negotiate to get the benefit of the bargain.

And finally, while purchasing offers advantages for people with a limited amount of cash to put down at closing, a lease will always engender a “drive away fee,” which can be a few thousand dollars.  Many times, the consumer will just need a little extra help to come up with this fee, and that is where EFT Direct comes in.  We make a sale happen.  EFT Direct stands in at the point of sale and allows the consumer to write up to four checks to be deposited over the next 45 days, so they have some extra time to come up with the money, without applying for credit or paying any additional interest.  The multiple check program is an absolutely indispensable tool for the dealer, whether they are leasing or selling a car. Best of all, it gives the consumer peace of mind, resulting in a higher Consumer Satisfaction Index score for the dealer, which makes the dealer more money too through the initial sales, factory incentive payouts on new car sales, and future sale of parts and services, and a long-term relationship with a customer who would have left the dealership and gone to a competitor or purchased no car at all. EFT Direct makes a win-win situation happen.

-Brandes Elitch

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