According to a new study by Edmunds, Millennials lately are leasing cars much more than older buyers. While leasing can be great way to get a new car and keep your monthly budget manageable, some young buyers don’t seem to be approaching leases the right way.

Before we start on why leasing may not be the best idea, let’s examine from that Edmunds story why Millennials do it in the first place:

According to Edmunds’ analysis of car registration data provided by Polk, leasing has accounted for 28.9 percent of all new car purchases by Millennials (age 18-34) in 2015. The percentage exceeds the industry-wide lease penetration rate of 26.7 percent, and reflects a 46 percent increase in leasing by Millennials over the last five years. By comparison, the share of leasing among all car shoppers has increased 41.7 percent during that period.

“Most Millennials understand and accept that they’re on a tight budget and that they need to stick to it,” said Edmunds.com Director of Industry Analysis Jessica Caldwell. “But it doesn’t mean that their financial constraints limit them only to the most basic vehicles to get from Point A to Point B. If they see a chance to get into a nicer car while staying within their budget, they’re likely to explore that opportunity. In most cases, leasing opens the door to the bells and whistles that they couldn’t otherwise afford.

Emphasis mine, because that’s really why everyone leases: to get a nice, new car for a lower payment than if you financed it outright. That story says Millennials are leasing $35,000 cars when their budget would normally limit them to $20,000 or less if they financed.

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But the problem arises when buyers seek to lease a car and then buy it later, a strategy called leasing to own.

I frequently get emails from readers about leasing, many of whom are doing it for the first time and are still confused about the ins and outs of the whole process. Here is a note that encompasses several misconceptions about leasing:

I’m looking to buy a new Mazda3, but leasing seems like it would be cheaper? I’m not quite sure if I understand leasing completely. My goal would be to buy the car after the lease ends. It seems like leasing will always be cheaper because A. the first 36 months of payments you’re not wasting money on paying interest on a loan and B. most maintenance is covered by the dealership during the 36 month lease.

Assuming I buy the car in the end, the loan I take out for the car will be much lower, the length will be shorter and I’ll be paying less interest on that smaller loan balance. Am I off anywhere? What’s the catch?

First of all, kudos for actually reaching out to someone rather than just rolling into the dealership and trusting them to give you honest information about your lease. The major issue that comes up is that younger buyers are using leasing as a stepping stone to ownership of the same car. But let’s take these concerns one by one:

My goal would be to buy the car after the lease ends. It seems like leasing will always be cheaper because A. the first 36 months of payments you’re not wasting money on paying interest on a loan...

It all depends on what you mean by “cheaper.” If you are strictly referring to monthly payments, then yes, a lease will have lower monthly payments within the same 36 month period in opposed to a purchase. However, if your goal is to own the car, your total cost of the lease payments plus whatever loan payments you have on the remaining balance may end up being more.

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For example, if we take the current offer on a 2015 Accord sedan at $189 a month for 36 months with $1,999 down we can run a total cost comparison.

Whenever you see these specials you really have to dig into the fine print. Unlike Mazda, who an be pretty skimpy with details on their website, Honda lays it all out for you:

“Closed end lease for 2015 Accord Sedan CVT LX (CR2F3FEW) available from July 7, 2015 through September 7, 2015, to well-qualified lessees approved by Honda Financial Services. Not all lessees will qualify. Higher lease rates apply for lessees with lower credit ratings. MSRP $23,725.00 (includes destination, excludes tax, license, title, registration, documentation fees, options, insurance and the like). Actual net capitalized cost $19,745.12. Net capitalized cost includes $595 acquisition fee. Dealer contribution may vary and could affect actual lease payment. Total monthly payments $6,804.00. Option to purchase at lease end $13,286.00.

Honda states very clearly that you will pay $6,804 over the course of your lease then you will have the option to purchase your Accord for $13,286. What’s not included in these figures is your sales tax and DMV fees.

If you are going to lease to buy, you will have to pay these twice. Once when you acquire the lease, though you will only pay tax on the $6,804, and then again when you buy the car at $13,286.

Because sales tax and DMV fees vary from state to state, we will look at a base price comparison for total cost. For the lease you will have to put $1999 down, then pay $6,804 for your lease payments and finally get a loan for $13,286. This will bring you to a total cost of $22,089.

Now compare if you purchased the Honda at an MSRP of $23,725, you might be wondering why the lease is cheaper. The reason is automakers will subsidize a lease, or essentially make the dealer discount the car by a certain amount, to achieve that monthly payment. In this case the discount is about $1600. Getting that amount and much more off the purchase price of an Accord would be easy for even the most novice shopper. Even when the cars cost the same, you need to calculate for interest.

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Some people seem to think that you avoid interest on a lease. This isn’t true, leasing does have an interest rate and it’s called a “money factor” and while the total interest paid is less on a lease than on a loan, you aren’t getting that lease for nothing. Just like a loan, your credit score is still a huge factor and your payments can vary widely depending on your FICO.

If we look at our lease to buy situation again on the Accord we have the $1999 down, plus the $6,804 that already has the money factor calculated, plus the used car loan of $13,286. Currently, the average used 48 month used car loan is about 2.75 percent, for a total loan cost of $14,045. Then add the $1,999 and the $6,804 and you spent a grand total of $22,848. However, if you got the same $1600 discount and financed the Accord for 60 months at the current offer of 0.9 percent you would have paid a total of $22,225. In the lease to buy scenario you spent an extra $623 dollars, paid DMV fees twice, and it took and extra year to be free an clear of your loan.

The reason the lease to buy thing is tempting, is because too many buyers focus on monthly payments and not total cost. Honda’s offer of $189 a month is pretty feasible for most people; the downside to such a low payment is that in three years you have no ownership of the car and you have to start the payment cycle all over again. If you are the type of person that doesn’t mind having a payment, you are probably better off leasing another car rather than carrying a used car loan for several years on an out-0f-warranty vehicle.

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In addition to the low monthly payments, some buyers are under the impression that all leases come with other benefits that aren’t necessarily unique to leasing.

...most maintenance is covered by the dealership during the 36 month lease.

Most of your mainstream (non-luxury) brands don’t throw in free maintenance on your lease. Toyota has ToyotaCare, but only covers up to two years or 25k miles, whichever comes first. That sounds pretty generous, but it really only means a few free oil changes as Toyotas don’t require much in the first two years of ownership. On the luxury side, one of the benefits of leasing a BMW is they will cover all of your maintenance for the first four years, including brakes. You’re on your own for tires. However, these maintenance programs are offered regardless of lease or purchase.

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Sometimes people confuse “maintenance” with warranty coverage. The nice thing about leasing is you always have a car within the warranty period in case something comes up. For young people with a modest income and no emergency fund, the thought of having a new car with a low monthly payment and not having to worry about repair costs is very appealing. Though, if you are going to lease with the intention of buying you will eventually have both a car payment and vehicle no longer covered by the warranty.

If owning the car is the ultimate goal, most buyers would be better off taking a longer loan to build toward ownership. This would allow them to sell the car at anytime and they would be free from the mileage restrictions on a lease. What you don’t want to do, as someone who is just entering the workforce, is lock yourself into a lease contract for a several years, especially if your job situation is not stable. You could get laid off or change to a job with a longer commute. You may get relocated to a city where car ownership isn’t necessary and/or is very expensive. Getting out of a lease early can be costly. Having a car you can sell quickly will give you more flexibility, as long as you are not upside down on your loan.

I’m not trying to suggest that Millennials should never lease. In many cases, they have done the math, don’t mind the payments, and like getting a new car every few years.

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However, before you sign up for that lease, take a serious long term look at your goals and financial situation. Maybe buying a lightly used pre-owned car with a CPO will give you both a budget friendly payment and the added peace of mind of additional warranty coverage.

If you have a question, a tip, or something you would like to to share about car-buying, drop me a line at AutomatchConsulting@gmail.com and be sure to include your Kinja handle.

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