THIS ARTICLE DISCUSSES the scenario for consideration in this series of presentations on using debt wisely. Is the statement: “Leasing a car is a useful option if you do not have the cash to buy the vehicle or to make the down payment for the car loan needed for the vehicle you like”, true or false?
This is generally true. The greatest advantage of leasing over buying a vehicle is that lease contracts typically require no down payment and relatively lower monthly payments. However, in evaluating the time value of money and the lack of equity in the vehicle after the lease period compared to buying the vehicle, buying would be the smarter move.
Yet, leasing a vehicle can be particularly useful if the vehicle is used for business purposes and so provides the tax deductibility of the related expenses. Working capital is more often than not scarce in most businesses, so the lower demand on cash over a sustained period by the leasing option can serve to boost the availability of working capital.
One of the drawbacks of the leasing option is that at the end of the lease, the lessee has no ownership rights. It would be necessary to arrange another lease contract or purchase the previously leased vehicle for its residual value. The residual value is the price you will have to pay at the end of the lease to purchase the vehicle.
Another major drawback of the leasing option is that car dealers can draw the lessee into leasing much more than may be needed. This is because the lease payment is relatively low and the lessee may be drawn in by what he can afford to furnish as a monthly payment. The lessee may give in to the temptation to take on responsibility for a far more expensive and luxurious vehicle than what really would make sense financially.
The lease payment is very dependent on the residual value of the vehicle. For example, say you undertake a four-year lease of a $50 000 vehicle and the lease contract identifies the residual value of the vehicle at the end of the four years as $26 000. Then, the $24 000 in value lost over the lease period is what is spread over the four years – say $500 per month. That is built into your monthly lease payment calculation along with the interest, taxes and other fees that the leasing institution will charge you. The monthly lease in this example will likely be of the order of $750 per month.
With a higher residual value quoted for the same vehicle, the monthly lease payment would be lower and vice versa. Obviously, then, this is a very important aspect to be negotiated when entering into a lease. It would be quite reasonable too for the lessor to qualify any upfront residual value quote by the requirement for reasonable wear and tear in the use of the vehicle over the lease period.
If driving a new car with the latest technological gadgets and safety features gives you commensurate value, yes, leasing may be your option to always having an enjoyable and prestigious vehicle. However, bear in mind that when you buy the vehicle, you can treat it as you like and not be bonded by stipulations that may be in a lease contract. Eventually, the loan will be repaid and you will have those monthly instalments to fund other needs in your life.
In the long term, the option to buy is better than the lease option. Furthermore, in spending wisely, it pays to buy well within your means – so buying a used vehicle can prove to be the smartest move in terms of long-term out-of-pocket cost as well as in maximising ownership value.
• Louise Fairsave is a personal financial management adviser, providing practical advice on money and estate matters. Her advice is general in nature; readers should seek advice about their specific circumstances. Email: Louisefairsave@nationnews.com
This column is sponsored by the Barbados Workers’ Union Co-op Credit Union Ltd.