You don’t have to look far to see that there is currently something unprecedented going on in the automotive industry. From the empty dealership lots you drive by, to the news stories you’re hearing about a “chip shortage,” it’s clear something very serious is impacting manufacturers, dealers, and ultimately people like you and me; consumers.
We’ve documented in the past how the ongoing semiconductor (chip) shortage is wreaking havoc on manufacturer’s ability to produce new vehicles. Ford is storing F-150’s in country fields and race tracks, Jaguar Land Rover is informing their investors that they’re losing more money than anticipated because of the shortage, and dealers are making record profits because they can sell their limited inventory above sticker price (MSRP).
To suggest that what’s going on in the market right now is ridiculous would be an understatement. We’ve never seen anything like it.
Traditionally, buying a car can be pretty intimidating. You find something online, go into the dealership, sign the paperwork and then you’re left wondering, “did I get a good deal?” In today’s market the answer more and more frequently is “no.”Become a FREE CarEdge Member
Uninformed buyers are agreeing to pay for crazy add-ons, unheard of additional dealer markup, and ridiculous F&I products, simply because they don’t know better. That’s why today we want to share with you the simplest explanation for why you should be leasing a vehicle right now instead of buying it. If you know someone who is thinking about getting a car in this market, please consider sharing this with them.
Here we go …
Why you don’t want to finance a car, truck, or SUV right now
To understand why leasing is the smarter option today, let’s start by explaining why financing (i.e. taking out a loan to purchase) a vehicle is not advisable right now. I wrote about this in depth a few weeks ago, but the long and short of it is this:
Vehicle prices are inflated, which means the loan you take out on the vehicle will be for the inflated purchase price. Let’s say you get a five year loan, well, over the next five years as vehicle prices normalize, you’ll still have your loan for the original amount (when prices were inflated). This means you’ll be in a major negative equity position (the vehicle will be worth considerably less than what you owe on the loan).
Why is this important? Because in normal times many people would find themselves in $2,000 to $3,000 “negative equity” positions, and that was without inflated vehicle prices at the time of purchase. In today’s market, those same people will find themselves in much more severe negative equity positions because they took out a loan on something that isn’t actually worth as much as it’s selling for right now.
So what options do you have?
Leasing means you don’t own anything, and that’s great
This is where leasing comes into the picture. When you lease a vehicle you don’t own it, you rent it. Leases make a lot of sense in today’s market because they allow you to fulfill your need (having mobility), while also mitigating your risk of taking on debt that will burden you into the future.
Let’s look at a tangible example. Here’s a lease deal for a 2021 Toyota Camry:
You can see the MSRP is $26,701, and the dealership is selling the vehicle at that price. The residual value is down in the bottom left, and it is 52%. That means that at the end of the lease term (36 months and 36,000 miles) the leasing company (Toyota Financial Services) expects the vehicle to be worth 52% of its original value ($13,885).
The residual value is not negotiable. It is the best guess from Toyota as to what they think the vehicle will be worth at the end of the lease term. Since the pandemic we have not seen meaningful changes in residual values. This makes sense, because the residual value is an estimate as to what the vehicle will be worth in three or four years, not next week. Even with inflated vehicle values today, leasing companies expect their vehicles to return to a normal depreciation curve in the future.Become a FREE CarEdge Member
By leasing, you are effectively renting the vehicle for 48% of its depreciation.
Your other option is to finance the purchase of the vehicle. If you do that you will be financing the total purchase price, plus taxes, plus fees. On this Camry deal that likely comes out to $30,000. Typically Camry’s would sell with a dealer discount and significant manufacturer rebates. Obviously in today’s market that’s not what’s going on.
Once used vehicle prices return to normal and this Camry depreciates as expected, you’ll owe significantly more on the loan than what the vehicle is worth. Compare that to our leasing option, and after three years you can walk away from the lease and purchase a Camry then (likely with the dealer discount and the manufacturer incentives we’re accustomed to).
The real benefit of leasing right now is that it means you will not be in a severe negative equity position in three years, and by that time vehicle prices will have normalized as new car supply has returned to normal. At that point it would make much more sense to purchase a vehicle (new or used) since their prices will not be inflated.
In the meantime, if you do finance a vehicle, be prepared to face a sobering reality when you check the value of your vehicle in 24 months. It’s going to depreciate, and if your loan is for thousands of dollars more than what it’s actually worth, that’s going to be a tough pill to swallow.