Last week I wrote an article talking about how to save boat loads of money by purchasing the car of your dreams but only after it is two to three years old. This week I want to talk about how leasing a car really works and some tips to save you more money on that next car purchase or lease.

What is a lease? A lease is an agreement you enter into to rent your car for a predetermined length of time (usually 24 to 36 months) for a predetermined monthly payment, and for a set number of miles. These payments are always less than the payment would be if you purchased the same car on the same day. The lower payment means that the car looks more affordable on the surface but inside of that lease agreement are all kinds of terms that can cost you far more than just the lease payments.

To begin with, why is the payment less expensive with a lease than with a loan for the same car? When you lease you are only paying for the estimated depreciation during the length of that lease rather than the entire loan balance you would pay back during that same time frame. As an example, you borrow $25,000 and sign a 36-month loan agreement at 5% giving you a payment of $749.00 which is a very hefty car payment by today’s standards and for many people that payment is not an option based on their income and budget. However, if you could swing that payment for those 36 months you now have a free and clear car with a lot of life left in it and if you were smart and disciplined you would continue to make that big payment but now into a tax-free account. (More on this in next week’s part 3)

In contrast, when you sign a lease on that same car for 36 months your payment might only be $300.00 for a 36-month lease which is much easier on your pocketbook. However, after the 36-month lease, you still have a balance to pay off if you want to own the car. This balance is called the residual value and must be paid off either by cash or with a new loan. Most people will not have the cash to pay off the car and so if they decide to own the car they now take on another loan for several more years to actually get the car paid off. Most people do neither of the above but turn the car in and get the next newest model and take another lease payment and so on and so on until they are old and gray.

In essence, a lease allows you to extend your payments on a car for 6 to 8 years paying far more in payments and interest (yes there is a hidden interest rate with a lease) for the same car. You have less of a monthly payment, but way more of them totaling more money out of your bank account. So how about we actually have a strategy for our next car purchase instead of just winging it? If you can’t afford the 3-year payment then how about committing to no more than a 5-year note on your car? Can’t afford that payment either? Then the truth is you really can’t afford that car. Shop for something less expensive and possibly a model year or two older. Now make a commitment and plan that after you pay off the car you will not buy another one for just two more years but you will continue to make a car payment to yourself into a tax-free account. According to www.polk.com the average length of time people hang on to a car is almost 6 years so you will go one extra year for good reason.

It will look like this in real numbers. You borrow $25,000 at 5% for 5 years on your next car creating a $470.00 payment which you pay for 5 years. Now you own the car free and clear but what will you do with the payment you were making? Blow it on junk if you’re like most people but you are not like most people. You have a plan that you are working. So now you still write that payment from your checking account every month but now the money goes to a bank (or pool of money) that you control.  You will do this for the next 24 months accumulating $11,322 plus the growth on that money (guaranteed and tax-free if we do it right) which would put you at a total of about $13,000 you have saved for yourself and your family. That $13,000 in a tax-free account that just gets 5% compound interest will be over $35,000 for you in 20 years. Could you do that on every car you and your spouse ever own? If you will do it you will have a couple hundred thousand dollars more for your family! According to The Employee Benefit Research Institute, the average American only has $56,000 in savings by the time they are 65 years old. So by mastering this car strategy, you could have 4 or 5 times that amount over your lifetime depending on when you start.

Yes, John but why do I need to make a payment back to myself instead of just letting the unused money sit in m checking account? Simple, human nature will not allow you to truly “save” your car payments unless you get the money out of your day to day cash flow and super easy access. Money is only saved if it is focused and not frittered away on other things we really don’t want or need.

Focused cash flow is the key to wealth and the disposition and growth of that cash flow are critical if you want to get ahead and have more options later in life. Did you ever “save” money on a big item? Where are those savings now? Precisely! Get in the habit of taking “savings” and truly making them savings by taking them out of your cash flow account and into a separate tax-free account.

Automobile ownership is a luxurious necessity in this fast paced world (in most places) and is a source of pride in owning a nice automobile. However, the dollars at stake here are massive over time and you need a strategy on how to stop the wealth drains of depreciation and interest on these purchases.