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Car leases are back: Should you bite?
With interest rates rising, leasing is getting more popular. So are long loans. Both have pitfalls.
May 26, 2005: 3:20 PM EDT
By Peter Valdes-Dapena, CNN/Money staff writer
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NEW YORK (CNN/Money) - Interest rates are rising and that means car payments are getting higher. Car buyers are responding to the pressure with two different strategies for keeping car payments lower without giving up on the luxury and options they want.

One strategy: Look into leasing again. Since hitting a low point in 2003, leasing is becoming more popular again, according to data from R.L. Polk & Co., an automotive market research company. Today, 14 percent of car shoppers end up leasing their cars.

That's because leasing looks more attractive as car payments for buying get higher and because people don't have the ready cash they had been getting from mortgage refinancing, said Paul Taylor, chief economist with the National Automobile Dealers Association.

But far more people have been opting for another approach to keeping car payments low. They are paying for their cars over a longer period of time. About 45 percent of car buyers now take out loans of 60 months or longer, according to data from the Consumer Bankers Association. That means more monthly payments, but each monthly payment is smaller.

The risks

Each of these methods carries some financial risk, but statistics indicate that many are paying a heavy price for taking the "slow-pay" approach when they probably should have leased.

The risk of the "slow-pay" approach is that it can leave you in a financial bind if you want to get rid of the car while it's still relatively new. The problem is that your car will be losing value faster than you are paying it off.

So, after three years of ownership, when you go into a dealership to trade it in on something new, you might find out that your car isn't worth enough to pay off all the money you still owe on it. This is what is known in the business as being "upside-down."

While the number of buyers who are upside down has been declining since 2003, when as many as 33 percent of buyers trading in a car were "upside down," the figure still stands at almost 27 percent as recently as April, 2005, according to data from the automotive Web site Edmunds.com. And the average amount they still owe on their trade-in is almost $3,600, according Edmunds.com's data.

Edmunds.com is a partner providing automotive data and content for CNN.com's automotive news and information Web sites.

For someone in this sorry situation, a lease would have been the smart way to go. In a lease, the monthly payments are low because you aren't actually paying for the car. All you are paying for is the loss in value during the time you own the car. In some cases, because of manufacturer incentives, you could even be paying less than that amount.

If you lease the car for three years then, when those three years have passed, you can just turn the car in, lease or buy another, or just walk.

But, what if you decide you like the car and you really want to keep it?

You could just elect to buy the car at the end of the lease term. That's always an option. But it will almost certainly cost you more than it would have to just buy the car to start with. The amount you pay to buy the car, added to the total of all your lease payments, will be more than you would have spent if you had just signed a straight financing agreement way back at the beginning.

On the other hand, it could well cost you less than buying the same car of the same age and in the same condition from someone else. And you know far more about your car than you ever will about any other used car.

So, if you really like the car, you could look at the extra cost of your years of leasing as the price of having a trial period. And, remember, the buy-out price is always negotiable. A car dealer has good reason to want to sell the car to you rather than selling it on the open market. For starters, it's just a lot easier.

Either way, whether you take out a super-long loan agreement or lease, it'll cost you to change your mind. Only take the long loan if you are sure you will hold and cherish this car for a long, long time. Only lease if you are fairly sure you'll be sick of it in three years anyway and want something newer and better.

Since the future -- and your changing needs and tastes -- can be hard to predict, the safest path is probably to buy the car and pay it off quickly. That leaves all your options open. If you want to get out of the car, you can sell it and maybe even have some cash left over. If you decide to keep it, you could have years and years of payment-free driving ahead of you.


Buy vs. lease and more

Edmunds.com tips and advice on car finance and leasing:

Financing basics

Financing pitfalls and solutions

How to spot a good lease

Cost compare: buying, leasing and buying used  Top of page


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