Understand Car Leasing the Easy Way

Although our Lease Guide thoroughly explains car leasing, the explanation can sometimes get a bit complicated and difficult to understand. The fundamental concept can get lost in the details.

Therefore, we offer here a simplified example to help explain the basic concept of leasing a car. It’s possibly a bit over-simplified and not quite realistic, but hopefully gets the message across.

In our simple scenario,  a consumer, Alan, wants a brand new car and approaches a dealer sales person, Jorge. The car that Alan wants is priced at $30,000. Alan also discloses that he always sells or trades cars every 3 years, takes good care of his vehicles, and drives only an average number of miles — about 12,000-15,000 miles a year.

Jorge explains that Alan has three options.

He first reminds Alan that an average new car driven average miles will lose 50% or half its original value in 3 years. It’s called depreciation and all cars suffer it. For our example we’ll use 49% to help keep our numbers straight. We’ll also ignore fees, taxes, down payments, and finance charges to keep things simple.

Option 1

Alan can pay $30,000 cash for the car, if he can afford it. His $30,000 completely pays for the car and there are no monthly payments. In three years he can sell it or trade it for the remaining 51% of its original value, after having lost 49% to depreciation. He has nothing to show for that 49% ($14,700) except the miles of use and enjoyment of driving the car over the 3 years.

Option 2

Alan can agree to a loan for the $30,000, to be paid over 3 years. After the 3 years, he has paid a total of $30,000 in payments, but only has $15,300 (51%) in value left after depreciation. He can sell or trade to recover that remaining value, but the other $14,700 (49%) is gone. This means about half of every month’s payment will disappear into the depreciation sinkhole.

Option 3

Alan can lease the car for 3 years.  For a lease he only has to pay for the expected depreciation of 49% ($14,700), not the entire $30,000. He can choose to pay it all at once, or pay it monthly for 3 years. At the end, he can return the car or buy it for the remaining 51% of original value. If he returns it, he has nothing to show of his payments for the 49% depreciation. However, this is the same amount that he loses with Option 1 and Option 2, except that his payments are about half of Option 2 loan payments, and he doesn’t have to put up the large amount of cash required by Option 1.

Decision

Alan decides to go with Option 3, leasing, because it offers a lower monthly payment (about half of loan payment amount), requires little up-front cash, and eliminates the hassle of selling or trading a car every three years — since he plans to simply return the car at the end of the lease. For Alan, leasing offers a convenient way to drive a new car every 3 years.

Footnote

Alan had heard for years from friends and family that leasing is not smart, that it is expensive, that it’s a dealer scam, that it’s simply long-term renting, and that it’s only good for businesses for tax purposes. However,  Alan spent some time reading the Lease Guide at LeaseGuide.com and found that his well-meaning advisers were misinformed, and that leasing works very well for the right people and the right reasons.