I don’t want to lease because it is so expensive to get out of the lease early.
We would agree that it is expensive to get out of a lease early. In a perfect world you want to match your lease term with how long you are going to keep the vehicle. But we realize that reality doesn’t always work this way and you may need to get out of a lease early. However, we don’t agree that this is a reason to avoid leasing because it is also expensive to purchase a vehicle and sell it after a few years. In many cases, you will have negative equity in this situation.
Let’s look at an example of a 2004 Lexus RX330 that you acquired in October 2003 and you want to get rid of it in October 2005. Let’s look at the consequences of buying it and selling it and signing a four-year lease and terminating it at the end of two years. The MSRP on the vehicle is $40,908 and you can purchase it for $37,100 plus sales tax at 6%.
Look at the table below for the costs of owning this vehicle. To make things simple, we assume that the down payment on the loan is equal to the initial lease fee, but any number would have worked. We calculated a 48 month loan at 6%, with an initial loan amount of $38,613.86.
Cost of Owning Vehicle
Look at the second table below for the cost of leasing the 2004 Lexus RX330. The initial lease fee is $741.64. You have 23 additional lease payments of $544.14 each for a total of $12,515.22. Different financial institutions use different methods to calculate the payoff on a lease. We have chosen the Constant Yield Method, which is the most popular one. Under this method, the lease payoff at the end of two years would be $29,223.49. Most lessors also charge and early termination fee on a lease. They will typically charge extra payments or a percentage of the residual. We have used a penalty of 2 extra payments in this example. We then show the same selling price of $26,590.20. The sum of these numbers is the total cost to lease of $16,978.34.
Cost of Leasing Vehicle
So in this example it does cost $601.47 more to end the lease early than to purchase and sell the vehicle, but this number is pretty insignificant compared to the total cost of ownership.
However, you may notice that the monthly cash flows between buying and leasing are not equal. When you purchase, your monthly cash outflow of $906.85 is $362.71 higher than the $544.14 lease payment. The purchaser only catches up at the end of the two-year period when the vehicle is sold. In reality, most people will invest their excess cash, often times in methods that you may not have thought of. Please see our article titled, “If I Buy a Vehicle, at the end of 4 years I have an asset, if I lease I have nothing”, for details of different investment options. If you could invest your $362.71 monthly savings at 8% you will earn $704.87 in interest over the two year evaluation period. This more than makes up for your $601.47 deficit.
If you are considering leasing and you think that there is a chance that you will have to terminate your lease early, make sure that you understand the early termination clause in your lease contract. In most cases there will be more than one financing choice available to you, each with its own cost of early termination. Sometimes it is worth it to have a slightly higher monthly payment in exchange for a better early termination option.
Analyzing early termination options is one of the services that we offer to our customers. If you have any questions or concerns in this area, please call us at 1-800-800-5327 or send us an email.