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Wheel Deal

Richard Connor

I’VE BEEN KNOWN to overanalyze decisions, especially financial ones. When faced with a money question, often my first thought is to create a spreadsheet. While this brings groans from family and friends, I find them a great way to clarify my thinking and gain insights. Sometimes the resulting insights are glaringly obvious, and I get to laugh at myself.

My wife and I were looking to replace her nine-year-old SUV. We had read and heard that new car inventory was the biggest problem we’d face, and boy was that right. Even tried-and-true cars that have been around for decades were tough to find.

The dealer we went to had three of our desired SUV, each with a different trimline. One was the version we were interested in, but not the color we preferred. There was no negotiating on price. We test drove the model we were interested in, but took a day to decide whether we could live with the color. I called and asked for a price.

The dealer sent me a link to a great website, which showed the detailed pricing, our trade-in value and final cost. The site also had several tools to allow us to investigate financing or leasing the car. We could evaluate different lease periods and mileage allowances. Based on our inputs, the site told us the monthly payment and residual car value. The residual value is the price we’d have to pay if we wanted to purchase the car at the end of the lease.

I understand many people pick a car based on what they can afford per month and structure the purchase or lease accordingly. But me being me, I had to evaluate all the options to see which was the best deal. The three options I considered were: buy the car for cash, finance some of the cost, or lease the car for three years and then purchase it. So off to Excel I went.

It seemed like a pretty straightforward series of present value (PV) calculations. These involve turning all costs into a single price that’s expressed in today’s dollars. PV calculations are based on the notion that, given a choice, we’d rather pay $1 later than $1 today, because in the meantime we could use the money to earn interest. Excel makes it easy to do PV calculations.

The manufacturer was offering 0% financing for 48 months. To evaluate the financing option, I added the money we’d put down, plus the trade-in value, to the PV of the 48 monthly payments. This total could then be compared directly to the cash price.

Evaluating a lease is a bit more complex. I took the money due at signing (again, including the trade-in value) and added it to the PV of the monthly lease payments. To make the three options consistent, I assumed we’d buy the car at the end of the lease, so I also calculated the PV of the residual car value. The total of these present values could then be stacked up against the cash option and the financing option. My goal: Find the lowest PV.

As expected, the lease was the worst deal. The PV of that option was about $2,100 more than the cash option. The financing option was the best. Its PV was $253 less than the cash option. In retrospect, this should have been obvious. Free financing, with no hidden fees, is always better than tying up your own money.

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After running the numbers on the three scenarios, I realized there was a fourth option to consider. In the scenarios above, you ended up owning the car. But many people lease a car and then turn it back in at the end of the lease. Why? Their employer might be paying for the vehicle, or perhaps they couldn’t afford to pay the residual value, or maybe they just like having a new car every few years.

In this fourth scenario, figuring out the cost of the lease is easy—you once again just add the money due at signing to the PV of the series of lease payments. But since you aren’t buying the car, this isn’t an apples-to-apples comparison to the first three scenarios. After thinking about this, I realized that instead of owning the car at the end of the lease, what you have is the money you didn’t spend buying the car. That, in effect, gives you the same PV as the leasing-and-then-buying scenario. My conclusion: The extra $2,100 you pay is for the privilege of leasing for three years and then having the choice to buy or not buy.

For those currently nearing the end of their car’s lease, that flexibility might be more valuable than usual. My sister-in-law’s high-end SUV just came to the end of its lease. She had intended to lease a newer version of the same vehicle but couldn’t find one that was available. That prompted her to look at buying her current SUV for its residual value. It turns out that the car’s current market price was significantly higher than the residual value, so she went ahead and bought it.  What if it’s the reverse situation—and used car prices have softened? A friend told me that several years ago he was able to negotiate $2,500 off the residual value when there was a large supply of his model on the used car market.

Still, most of the time, leasing will likely be the least attractive option. In running the present value calculations, I assumed a discounting interest rate of 0.4%, which is the current rate on my FDIC-insured online savings account. If I can find a higher safe return for this money, the financing option looks even better. What would it take for the lease option to look better than the cash option? I’d need to be able to invest my cash at a safe 4% a year—an impossibility these days.

Richard Connor is a semi-retired aerospace engineer with a keen interest in finance. He enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. Follow Rick on Twitter @RConnor609 and check out his earlier articles.

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booch221
booch221
6 days ago

The dealer sent me a link to a great website, which showed the detailed pricing, our trade-in value and final cost.

Why didn’t you link to the website or at least give us the name?

Jonathan Clements
Admin
Jonathan Clements
6 days ago
Reply to  booch221

I’m sure Rick will weigh in soon enough. But my understanding is that it was a site with a special login that was devoted solely to his particular car purchase, not a site where anybody can freely analyze any car purchase.

Rick Connor
Rick Connor
2 days ago

Jonathan is correct. It was a site the dealer sent in an e-mail for the specific care we were considering. I haven’t looked for a generic website but I might when I have some free time.

mike schellenberger
mike schellenberger
6 days ago

Nice article Rick. Still learning about PV calculations, I would love to see a little better explanation and some real numbers to help me better understand.

Bob Drake
Bob Drake
6 days ago

I keep cars for typically 6 years or so – lessens the cost of the early steep part of the depreciation curve with each new car – purchase or lease. At around 6 years the tech has improved enough to woo me to a new car even though the numbers say run it into the ground for best financials. A few family members tend to lease – not sure they appreciate the long term view – only that lease payments are lower – or perhaps they just want to upgrade quicker than I. The other thing I’ve noticed with their leasing situation is they are on the “clock” to make a decision on what to get next and timing it with their lease and as you pointed out currently there aren’t a lot of choices so that is another factor in the fixed timing of leases Sure, dealers will buy out your lease – but they are controlling things more than you. When you own the car you don’t have that additional timing constraint.

Randy Kleinman
Randy Kleinman
6 days ago

What was the great website the dealer sent you to?

Rick Connor
Rick Connor
2 days ago
Reply to  Randy Kleinman

It was a Honda site specifically for the car we were considering. It showed the car price, trade in price, and allowed us to look at different purchase/lease options. I should have made that clearer.

Roboticus Aquarius
Roboticus Aquarius
8 days ago

5 years ago we leased a car for the first time. I was the primary driver, and I wasn’t completely sold on driving it for 15 years. We turned it in 3 years later, bought a cheaper used car as we prepared to send our youngest to college. I think the lease was a good choice, given our circumstances.

I used an online site and an app to grade the lease terms. It seems we got an 8 or 9 out of 10; it was helpful to see this as it relieved our anxiety about overlooking something important. My wife and I both work in financial fields, and I think the dealer financial guy was ready to end us both by the time we were done reviewing and signing the lease contract. We recalculated every number on the contract except one we estimated due to a local tax thing we couldn’t confirm, and it took several times longer than most signings.

Otoh we closed the deal on our first car (20+ years ago) in about 20 minutes; in part because I had a really solid idea of prices, rates, payments, and where they all intersected, and in part because the sales guy was experienced and didn’t waste anybody’s time.

stelea99
stelea99
9 days ago

In my old age I’m getting lazy. For $253, it wouldn’t be worth it to me to have to make and keep track of 48 payments, adding a lender to the insurance, etc. Maybe the lender wouldn’t be happy with a $1000 collision deductible. Plus I have my credit frozen. Much easier to write one check and be done.

Rick Connor
Rick Connor
9 days ago
Reply to  stelea99

Using Honda finance made all this extremely easy. There were no extra fees. Otherwise I would have just written a check. And if rates go up, the $253 also goes up.

Harold Tynes
Harold Tynes
9 days ago

As a former finance leader in the financial services industry, the value of the residual at lease end is the key part of the lease transaction. Swings in residual value would make or break deals. Having a fixed residual value is risk mitigation. Are you comfortable with the value assigned? If you analyze a purchase transaction, what value are you assigning for residual?

Rick Connor
Rick Connor
9 days ago
Reply to  Harold Tynes

Thanks Harold. Thanks a great question. The way I approached it was to make it an even playing field. By this I mean that we would use the car the same no matter how we bought, financed, or leased it. So at the end of the analysis period the car’s actual value was the same in each scenario. I then calculated the PV of the three scenarios. Not sure if this the “standard” finance was of looking at the problem, but it made sense to me.

The analysis showed that the residual value specified in the lease was a big driver. The other thing I learned from speaking with fiends who lease often is that the assigned residual value is not written in stone. You can try and negotiate it at the end.

R Quinn
R Quinn
9 days ago

Hey Richard, it’s a car, just a vehicle By the time you finished your calculations you’re lucky there were any vehicles left to buy. That’s what you get for being an engineer. LOL 😁

Rick Connor
Rick Connor
9 days ago
Reply to  R Quinn

Thanks Richard. I do acknowledge it is a bit of a curse. I’ve learned that running numbers is my way of understanding the world. But its not for everyone, as my family and friends often remind me!

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