Why Car Leasing Is NOT Like Apartment Leasing

carlease-apartmentleaseIt’s unfortunate that the car business uses the same term “leasing” as the apartment business.

It causes confusion. It makes them sound like the same thing, which they are not.

It causes uninformed people to give bad advice to other uninformed people based on wrong impressions.

We see it all the time. Online advice forums on which someone advises someone else not to lease a car because “you make monthly payments and have nothing to show for your money in the end.” Actually, that’s true — but it’s based on incomplete facts that don’t tell the whole story, which is where the problem lies.

Let’s review apartment leasing for a moment.

The landlord of an apartment usually has a mortgage (loan) on his building. He’s paying interest on that mortgage. He has other costs — insurance, maintenance, taxes, and administration costs. When setting monthly payments for his individual apartments, he has to account for all his costs. Furthermore he wants to make a profit, and account for lost revenue from empty units, which adds to the amount he needs to charge his tenants, both of which are arbitrary costs and can vary widely. There is no formula that tenants can use to calculate and verify payments.

So, when a prospective apartment tenant is presented with a monthly payment amount, it is never broken down into individual cost elements and is seemingly completely arbitrary. In fact, the monthly payment for an apartment can easily be equal to or more than the payment on a condominium or house with similar qualities.  There is no inherent reason that leasing should be less expensive than buying.

So, that’s where the old but still valid advice originates: “Leasing means you throw your money away and have nothing to show for it. Buying a house for the same money may be smarter.” It’s typically true — for apartment leasing.

Now, let’s switch gears and look at car leasing.

Unlike apartment leasing, car leasing is a form of financing, not renting, and is based on a very specific cost-based formula. Monthly payments are not set arbitrarily.  Apartment leasing is like car renting, where rates are set on a cost and profit basis, not a financing basis.

Also unlike apartment leasing, you could never buy a car for the same amount you spend on leasing for the same or similar car, since leasing provides much lower monthly payments than a car loan. And there’s a good reason for that.

One of the characteristics of all new automobiles is that they lose value quickly as they are used. They depreciate in value. An average new car loses about 55% of its original sticker price in the first 3 years. The owner, whether it be an individual or a lease company, suffers this loss if they sell or trade the vehicle.

By contrast, apartment buildings generally don’t lose value during the time tenants “use” it. In fact, in good times, building values increase (appreciate) in value.

When a car is leased at a dealer, a lease finance company such as Ford Credit or Honda Financial buys the car from the dealer, and leases it back to the customer. The monthly car lease payment to the lease company is primarily determined by the amount that the vehicle is expected to depreciate in value over the lease term, assuming average use. The customer, who is going to be “using” the car, is expected to pay for that depreciation. If a car is predicted to lose 55% of its original sticker price, then monthly payments are structured to pay off only that 55%, not the entire 100% of the car’s value. That is why car lease payments are less than purchase loan payments for the same car.

This is a bit of a simplification because there are other costs in a car lease, including finance charges (since the customer is borrowing the value of the car during the lease — money paid by the lease company). There can be an acquisition (administration) fee, lease-end disposition fee (similar to an apartment clean-up fee), and fees for excessive wear-and-tear and damages at lease-end (also similar to apartment leasing).

Knowing the value of a car and expected depreciation, and finance charges, the monthly payment can be precisely calculated using a relatively simple industry-standard formula (see http://leaseguide.com/lease08). There are also online car lease calculators to make it even easier (http://leaseguide.com/calc).

In summary, it’s true that, when you lease a car, you make monthly payments and have nothing to show for it in the end. But those payments are a fraction of loan payments for the same car because you only pay for the amount that the car depreciates in value — the same loss that all car owners suffer. Whether you lease or buy, you always pay for that natural loss of value. The difference is how you choose to pay for it.

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