A New Look at Auto Leases

Why leasing can be the frugal choice.

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In our search for a new car, my husband and I spent weeks poring over advertisements in the Sunday paper, but we always got sidetracked by the lease offers. Stylish cars, like the Volkswagen Passat, could be ours for only $329 a month and no down payment—significantly less than we were prepared to pay to buy a car.

Most personal finance experts, however, consider lease deals to be the poisonous apples of the auto industry. Tempting, but always a bad idea. With a lease, the argument goes, your monthly payments build no equity, and at the end of your contract, you're left with nothing. But that reasoning doesn't take into account the subsidies that manufacturers and dealerships often offer on leases to persuade consumers to drive more cars off the lots.

Leasing peaked in popularity in the late 1990s, fell with the rise of zero percent financing in the early 2000s, and is now making a comeback as manufacturers and dealers once again devote more resources to lease incentives. They want to feed the strong demand for certified used cars (many of which were previously leased) as well as respond to the fact that interest rates have climbed from their historic lows in the early 2000s, making financing purchased cars more expensive. Last year, 27 percent of car sales were leases, compared with 22.5 percent in 2003, according to CNW Research.

Leases appeal not only to higher-income individuals who like to drive new cars but also to the budget conscious, because the monthly payments are typically about one half to two thirds the amount of payments on purchased vehicles, says Art Spinella, president of CNW.

Philip Reed, senior consumer advice editor for the car information site Edmunds.com and a former car salesman himself, recalls using leases to reel in customers on slow sales days. "Salesmen like leases," he says. "You'd say, 'What if I could get you lower payments and a lower down payment?' Then, the leasing begins."

Manufacturers and dealers can lower the price of leases even further by using inflated residual values, which is the estimate of what the car will be worth when the lease is over. That figure is then subtracted from the car's current value to calculate the monthly payments for the duration of the lease. The financial arm of the auto company is often willing to absorb that price difference in order to move more cars, explains Tom Libby, senior director of industry analysis at J.D. Power & Associates.

Sometimes, demand drives up the price of certain models. If you happen to have leased one of those hot cars, then buying it for its residual value at the end of its lease can be another way to win.

Deals. The safest way to come out ahead while leasing is to pick the car that comes with the largest subsidy, usually one of the less popular models. Unfortunately for our bank account, my husband and I had a specific car in mind that we really wanted—a Ford Escape Hybrid, which didn't come with any special leasing deals at the time. (Of course, our decision to buy a new car at all, instead of a used model, was already an expensive one.)

Our selection was based partly on the fact that my husband's father retired from Ford, which gave us an employee discount. Plus, because we plan to keep the car for the next decade, spending $27,000—a $9,000 down payment and $420 monthly payments for four years—should pay off in the long run. In contrast, leasing a new Passat at $329 a month would have added up to almost $12,000 after three years, and then we'd have to start all over again. So we bought the Escape.

Now the only debate is over who gets to drive it.