Lease vs loan: there is a cost difference
OTTAWA - Canada's auto guru Dennis DesRosiers has a quick response to the question of whether it's best to lease or finance a new car — pay cash.
That's what he does, for the simple reason it's the least expensive option.
But he realizes most Canadians can't just lay down tens of thousands of dollars at one go, or don't want to, so when asked about the remaining options, his response is more nuanced.
"It depends," he says, on what you expect out of your driving experience and whether you are more sensitive to the size of monthly payments or the end-of-use total cost of the purchase. And it depends whether owning a vehicle is important to you.
"The general rule of thumb is that if you are a consumer that changes vehicles every two, three or four years, leasing is a highly attractive option in most cases, though not all. The longer you keep your vehicle the more attractive loans become."
First, if you are the type of person who is addicted to the new-car smell, lease if you can afford it, he says.
But if you are looking for the least costly option and don't mind hanging on to your car longer — the average length of first ownership on a new vehicle is 9.2 years — then leasing is likely the worst thing you can do, DesRosiers adds.
The funny thing is that it may not appear that way when negotiating a financing arrangement at the local car dealer.
Invariably, the monthly payments on a lease are lower than on loans even though the posted interest rate is almost always higher. And leasing appears so worry-free. Take a new car, drive it for three years, then return it and get another new car. Repeat the process.
"It's the voodoo of leasing," DesRosiers says. "Leasing is absolutely the highest cost of borrowing in the market place. Hands down, no exceptions, but it doesn't look that way."
Why is that? Monthly payments are comprised of two components — interest on the principal or cost of the vehicle, and paying down the principal. On a loan, the paying down the principal portion can be quite steep because the buyer is paying off the entire cost of the vehicle during the financing term. On a lease, depending on the end residual value, the consumer may be only paying down half the cost of the vehicle.
That's why monthly payments are usually lower, but at the end of the lease, the consumer doesn't own the vehicle and will have paid more in interest than on a loan.
"The embedded interest in a lease is typically about $100 a month higher than the interest on a loan," DesRosiers says.
As well, there are additional costs that could accrue on a lease, and they can be substantial. Leasing companies insist a vehicle be returned in good working order and with "normal wear and tear."
What that means is open to interpretation — with the consumer having little input — but it usually requires replacing tires, possibly a brake job, and body work for bumps and scrapes that may have occurred. The end-of-lease surprise can add up to hundreds and even thousands of dollars.
As well, DesRosiers says many consumers wind up paying hefty penalties if they put on more than 25,000 kilometres a year, not that unusual since the average driver in Toronto clocks in at over 30,000 annually.
"So leasing is a consumer beware item," he says.
That doesn't mean it's the worst choice, however. Silvana Aceto of the Canadian Automobile Association says her organization advises members to do the math, but also to consider their personal circumstances.
"Some people like the flexibility of a lease, they like to have a new car every two or three years, and they don't have to worry about maintenance because when the car is new, usually that's when repairs are the fewest," she says.
You may not own the car at the end of the lease term, but then you don't have the worries older cars can bring, including breaking down and repair costs.
Aceto says the CAA does not pick sides, but advises members to "do the math" and consider carefully their preferences.
DesRosiers agrees. If he has one hard-and-fast rule, it's never get into an open ended lease where the customer is responsible for assuming the residual value — what's left owing on the car at the end of the lease period.
"Residuals are extremely volatile and nearly impossible to predict. Billions have been lost in residual value (usually by auto companies) over the years," he says.
By DesRosiers' calculations, about 18 per cent of Canadians leased their vehicle last year, while the vast majority financed. That's about right, he says.
"For 15 to 20 per cent of customers, leasing is a viable option, but for the rest they would be better off financially with a loan," he says.
"The issue is not whether you would like a new vehicle every three years, it's whether you can afford a new vehicle every three years and most consumers can't."
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