To Lease or Purchase a Car: Boiling It All Down

There are signs that the economy is picking up and that consumers are returning to the malls and auto showrooms. However, instead of buying new cars, an increasing number of individuals are opting to lease.

The appeal of a lease is that it can significantly reduce down payments and keep monthly payments reasonable. That’s attractive to someone who has little money saved and no trade-in.

But there are also disadvantages to car leasing.

First and foremost, it’s hard to tell how much you’re paying for the car, so many consumers end up paying too much. Salesmen make the problem worse by concentrating solely on monthly payments.

“What can you afford?” is the typical refrain. Payments can drop from $500 to $250 in a nanosecond. But don’t be dazzled. The salesman may have added two years to the lease obligation in exchange.

Other disadvantages revolve around unexpected liabilities that hit those who drive more miles than the lease allows, turn in cars early or who take poor care of the vehicle.

Most of these disadvantages can be overcome. But consumers need to determine whether they’re good candidates for a lease or if their personal habits favor buying the car instead. And, if they opt to lease, they need to do a little homework to ensure they get a good deal.

Determining whether to buy or lease should hinge on the answers to a handful of questions, including how long the individual will keep the car.

Leases usually last from three to seven years--the longer the term, the lower the monthly payments. But consumers should never agree to lease a car longer than they’ll want it. They are contractually obligated to make all their lease payments, whether they still want the car or not.

Often, the only way to get out early is to advertise and sell the lease like you would a used car. But that’s no picnic. Buyers usually must be approved by the leasing company. And if they fail to make their payments, the original lessee may still be legally on the hook, said Joe Scharfenberger, president of Chase Auto Finance, a division of New York-based Chase Manhattan Bank.

The second question is mileage. Those who drive only the specified number of miles allowed under the lease are in good shape. But those who exceed the limits usually get hit for extra charges that range from 12 to 15 cents a mile. Someone exceeding the lease allowance by 10,000 miles, for example, could be forced to pay a mileage charge amounting to $1,500.

Consumers must also consider how well they care for their cars. Leasing companies exact damage penalties against anyone whose car shows more than “reasonable” wear and tear.

Finally, be wary of “open-end” leases. They leave the consumer vulnerable to financial liability if the car depreciates faster than expected. This liability is sometimes limited by state law, but it often amounts to hundreds--even thousands--of dollars. “Closed-end” leases, on the other hand, shift any risk of depreciation to the dealer.

Overcoming most other leasing woes is as simple as carefully negotiating terms in advance. To do that, consumers need to do a little homework. The first steps:

* Determine how long the car is needed and an appropriate mileage allowance. Someone who has 60,000 miles on a 5-year-old car drives an average of 12,000 miles a year. If that pattern isn’t likely to change, they’d be foolish to agree to a lesser mileage allowance.

* Get the information and equipment needed to negotiate the price. Namely, find out how much it would cost to buy the car; determine the current auto financing rate, and buy a $25 calculator that has a present value function. (It calculates the total cost of an item bought on credit.)

* Prepare to calculate the present value of the deal you’re offered and compare it to what it would cost to buy the same car. To do that, you’ll also need to know the monthly payment; the number of months in the lease; the “residual”--how much it would cost to buy the car at the end of the lease, and the amount of any non-refundable deposit.

Here’s an example based on a car advertised in a major newspaper.

A Honda Accord DX sells for $11,788. The same car can be leased for 60 months at $159 per month, plus a $1,500 “rental reduction”--that’s the non-refundable down payment. The residual is $6,730. (Current auto financing rates are 10%.)

How does the lease compare to the purchase? We’ll go through the steps using a Texas Instruments BA-35 present value calculator ($22.95 at a local variety store).

Those with the same calculator must first switch over to the financial functions by hitting keys marked 2nd and N. (A tiny “fin” will show on the screen to show you’ve done it right.)

Now, hit 159, PMT (payment). Next put in the number of months in the lease--60--and hit the N key. Then divide 10 (the annual interest rate) by 12 (months) to come up with .83, and hit the key marked “%i.” Now hit CPT (compute) and PV (present value). The result should be $7,490.33.

The second step is to take the residual amount of $6,730, hit FV (future value); 60, N (number of months); 0, PMT; .83, %i. And CPT, PV. Result: $4,098.54.

By adding $4,098.54 (the present value of the residual) and the $7,490.33 (present value of your payments), plus the $1,500 non-refundable deposit, you get $13,088.87. This lease costs about $1,300 more than it would cost to buy the same car and finance it at a 10% interest rate.

If all this seems a little complex--and it should--practice a few times with advertisements that spell out the needed information before you see a car dealer. That $25 calculator and a little practice could save you $1,300.