A glance at the newspaper or a quick click to a local car dealer’s website reveals a dizzying array of promotions and offers designed to entice consumers onto the dealer’s lot, where the well-paid professional sales staff has a better than even chance of putting a person in a new car. Auto sales may be the one place where the average consumer runs head-on into what is called an asymmetry of information.
In other words, the dealer has more information about the price of a new car than the consumer does. The dealer knows, for example, exactly how much the car originally cost, how much it costs to keep that car in inventory and at what price the car can be driven off the lot with a decent profit left behind in the dealer’s pocket.
That does not mean that all dealers are liars and cheats. What it does mean is that when consumers are shopping for a new car, they need to do what they can to gather as much information as possible in order to reduce the asymmetry.
One of the most basic decisions a consumer has to make is to choose between buying a car or leasing one. Carmakers routinely make purchase, lease or financing offers to consumers on a variety of vehicles for a variety of reasons. Dealers sometimes add to these, again for a variety of reasons. We’ll leave the “why” for another time and try to make some sense of the “what” for now.
The choice between buying or leasing a car depends to a large degree on what a particular consumer’s needs and wants are. Typically, monthly lease payments are lower than repayments on a purchase loan for the same car. That means you can lease the car for a lower monthly out-of-pocket cost for the use of the car.
It’s important to think of buying or leasing a car as two sides of the same coin. Both provide consumers with the use of a car in exchange for cash. That’s the simple bit. It gets more complicated quickly.
Regarding monthly payments, loan payments are usually higher than lease payments, according to Consumer Reports magazine, because buyers are paying off the entire purchase price of the car plus interest, finance charges and fees. Lessees only pay for the car’s depreciation during the lease term, plus interest (rent) charges, taxes and fees.
Here’s the example Consumer Reports gives:
For a 36-month loan on a $36,000 car, for example, the principal portion of the payment averages $1,000 a month. But with a lease, you pay back only the vehicle’s decline in value—the depreciation—while you’re using it.
Since that $36,000 vehicle might depreciate about $18,000 over that same 36 months, the principal portion of the monthly lease payment would be based on $500, about half as much as for the loan. Of course, at the end of the lease, you have to return the car (unless you come up with the remaining $18,000 of the residual value to buy it).
To the principal consumers need to add finance charges. With a lease, you are paying off the cost of the principal more slowly, which means that you are paying more in finance charges because you are using someone else’s money for longer. Consumer Reports reckons that the 36-month lease on a $36,000 car costs about $1,435 more in finance charges. Some of that is returned by a tax break to lessees, and if you can invest the difference between a monthly loan payment and a monthly lease payment, the difference between financing a loan and financing a lease shrinks further. But Consumer Reports also notes:
Taken together, those benefits might offset the higher lease finance charges. But even then, lessees often have to contend with various fees and other extra costs, including lease initiation and disposal fees, which can add hundreds more to the total cost.
All these additional costs are multiplied if you lease another car whenever your old lease runs out, although some may be waived through lease-loyalty programs.