Cars – love them or hate them, for many people they are the largest area of monthly expenditure besides your mortgage or rent, and therefore one of the best areas to improve your financial standing by making an informed decision.  When it’s time to get your next car, a big argument many times is whether to buy or lease.

As a general rule, I would say to buy your car if you plan to keep it for 5+ years, and also to make sure to purchase when the car is one to two years old to stave off that initial depreciation hit.  If you like driving the latest and greatest though, many times a lease would be the best option.

Upon first inspection, a lease is a complex financial transaction that many people don’t completely grasp, but it’s essentially broken down to this: the manufacturer guesses what its car will be worth in x months, and then you finance the amount between the negotiated price of the car and that guess (the residual), plus interest.

This brings to the forefront one of the biggest things to realize when you are leasing – negotiate it the same as you would a purchase transaction!  The only non-negotiable figures here are the residual and the base money factor (do your research and don’t let them tack on profit here), and in most cases the bank fee. 

I have a few additional rules for leasing if you’re going to go that route in order to get the most bang for your buck.

1. Pick a car that holds its value well.  Residuals vary greatly depending on the car and mileage.  For example, if you were going to buy a new BMW 328i, the residual for 36 months, 12k miles/year is 63%.  On the other hand, it wouldn’t be wise to lease a Dodge Durango, whose residual for an identical lease is 38%.
2. Pick a car that the dealer is running a special on.  Even the high-end brands have models that they are trying to promote with a good money factor.  A money factor is just an interest rate expressed in a different format.  You multiply by 2400 to get the interest rate (ie a MF of .00118 is an interest rate of 2.832%).

You’ll hear people say that you shouldn’t do a lease, because at the end of the lease you don’t own anything – this is a gross misunderstanding of finance, so don’t fall for that line.  At the end of three years, you’ll own a car as much as they do after a purchase – most car loans go 60-72 months these days, so the bank still owns their car also.  After all, you’ve heard the adage that you buy appreciating items and lease depreciating items, right?

The one thing I would recommend against is purchasing a car at the end of a lease – if you plan to buy your car at the end of the lease, just buy it now.  The goal of the lease is to pay the least amount possible for the amount of time you have the car, and then to turn it back in to the dealership so they take any possible loss from extra depreciation.  On the flip side, if they have underestimated the residual of the car and you think you can make a few grand off buying the car at the end of the lease and then selling it private party, more power to you!  What do you think?  Let me know in the comments!