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Ask Dr. Don
Bankrate.com

Lease vs. own an auto

Dear Dr. Don,
I lease an auto. Can I buy it outright? If I do, will it save me money?
Susie Savings

Dear Susie,
Good question. Most leases have a payoff amount, just like an auto loan, where you pay the money and the car is yours.

Ignoring for the moment any early termination fees, you'd save the interest expense over the remaining life of the lease. You would also get your full security deposit back and not owe a vehicle disposition fee. But if you bought the car at the end of the lease you would also get your full security deposit back and not owe the disposition fee.

Early termination fees are common when you want to get out of a lease. Along with an early termination fee, you can expect to pay any unpaid depreciation. Autos depreciate more rapidly in their first few years. The rate of depreciation declines over time. Leases charge depreciation at a constant rate over the lease term.

That means that you're not keeping up with the car's depreciation in the early years of the lease. This difference is often called the gap. You can buy gap insurance for leased vehicles to protect you from owing this money if the car is totaled or stolen, but it won't cover your decision to buy out your lease.

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The capitalized cost financed at the beginning of the lease is paid down to the vehicle's residual value over the lease term. You can easily be upside down in your auto lease, where you owe more than what the car is worth. Whether you pay off the lease or continue in the lease, you'll wind up paying for this depreciation, so paying it now isn't as onerous as it may seem.

The easiest way to look at this is to assume that you're using your savings to make the lease payments and that you would have bought the car at its residual value at the end of the lease.

I've shown an example below. Buy the car out of the lease and you lose the interest income that the savings would have earned over the life of the lease ($822), but you gain the interest income from being able to invest a monthly amount equal to the monthly lease payment ($172) and save the remaining rent on the loan ($1,479).

Initial lease terms

Capitalized cost

$25,000

 

 

 

Residual value

$12,000

 

 

 

Lease term

36 Months

 

 

 

Money factor

0.00333

 

 

 

Sales tax

6%

 

 

 

 

 

 

 

 

 

Total

Monthly

 

 

Depreciation

$13,000

$361.11

 

 

Finance (rent) charge

$4,436

$123.23

 

 

 

 

 

 

 

Total sales tax

$1,046

$29.07

 

 

Monthly lease payment

$17,436

$484.34

 

 

Total monthly lease pmt.

$18,483

$513.41

 

 

 

 

 

 

 

Analysis

Remaining lease term

12 Months

 

 

 

Residual value

$12,000

 

 

 

Unpaid depreciation

$4,334

($361.11x12)

 

 

Early termination fee

$450

 

 

 

Payoff balance:

$16,784

 

 

 

 

 

 

 

 

 

Loss

Gain

Net

 

Interest income @ 6%

$(822)

$172

$(650)

 

Early termination fee

$(450)

 

$(450)

 

Rent savings

 

$1,479

$1,479

($123.23x12)

Benefit

 

 

$379

 

Leasing calculations used Bankrate's leasing calculator.

 

Determine your lease payoff amount by contacting the leasing company. Break that number down into its component parts of: residual value, unpaid depreciation and early termination fee.

Remember that you're paying the residual value and the depreciation regardless of when you buy the car out of the lease. The early termination fee and the rent savings vs. lost interest income become the key components in the analysis.

You can estimate the interest income gains and losses by figuring the average annual balances and multiplying by the interest rate you would expect to earn on the investments for each year of the lease remaining. In general, you would expect the interest income that you would earn on your short-term investments to be less than the rent savings by buying the car out of the lease early. That means the size of the early termination fee is critical in determining whether to buy the car.

In the example above, I wouldn't buy the car out of the lease early to potentially save $379. Being able to keep my options open for another year while I decided whether I wanted to own the car would be worth forgoing the potential savings.

Getting a car loan to buy out the lease can be a more difficult proposition. You don't have any equity in the car and the unpaid depreciation can place you upside down in your lease. The financing costs for a used-car loan are likely to be higher than the current rent on the lease. You're also likely to be better off waiting until the end of the lease to make the decision whether to buy the car.

-- Posted: April 22, 2002

Read more Dr. Don stories here
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See Also
Leasing your auto
Key leasing questions to ask
More Dr. Don stories

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