By Phil West, WCI Contributor
You are not what you drive. And you really shouldn’t define yourself by a car you’re only leasing for three years.
In a number of past articles on The White Coat Investor, we’ve looked at how much people pay for new cars compared to used cars, and our recommendation for those still needing to build wealth is to purchase a used car instead of a new one and then drive it as long as you possibly can. In the long run, it’s often less expensive to maintain a used car than to pay for a new one, and used cars can be incredibly reliable. And if you do happen to buy a new car, we recommend that you drive it for a long time and that you don't lease it.
Today, let's talk about why doctors (or, really, anybody) shouldn't lease a car and what you should do if you already have one.
Why Buying A Used Car Is Better
In this article on how to buy a car, we did some simple but amazing math to show just how far owning a new car can set you back.
As Dr. Jim Dahle wrote, “If you only make $50,000 (the average American household income) and are losing $5,000 a year in auto loan interest, repairs, and car depreciation, then it becomes very difficult to get ahead.” He then noted, “If you really want to, you can probably save enough on your transportation compared to what a ‘normal’ person does to fund a Roth IRA every year—$6,000 a year from age 20 to age 65, invested at 8%, adds up to $2.5 million, far more than most people, including doctors, retire on.”
And that’s for a bad investment in which you’re actually purchasing something. A new car might be a depreciating asset that’s not advantageous to put money toward, but at least at the end of the loan, the car is yours. And it eventually becomes a car that you spend less on each year than a new one.
That's not how leases work, though.
More information here:
How Does Leasing a Car Work
With a lease, on the other hand, your payment might be comparable to what you’d pay on an extended car loan. But at the end of a typical three-year lease, you either have to pay a buyout offer to make the car yours or you have to find a new car. You could lease again, of course, but then you’ll just have more monthly payments that don’t get you anything at all. It’s the automotive equivalent of paying rent when you could instead be paying on a mortgage for a house.
As Consumer Reports observed, “On the surface, leasing can be more appealing than buying. Monthly payments are usually lower because you’re not paying back any principal. Instead, you’re just borrowing and repaying the difference between the car’s value when new and the car’s residual—its expected value when the lease ends—plus finance charges.”
But there are some possible hidden charges that can make what you’re paying each month more expensive than even buying a new car.
Most leases will hold you to a mileage limit. Let’s say that your mileage limit is 30,000 miles over three years, and between some road trips and unexpected commutes, you go over that limit. You could be charged anywhere from 10 cents to 50 cents for driving any mile over the limit. If you go 10,000 miles over during those three years, which is less than 280 miles a month or about 9 extra miles a day, you’re looking at a penalty from $1,000-$5,000 at the end of the lease, depending on the per-mile cost.
And just because you’re driving a car for three years doesn’t mean the leasing company will expect the car to be returned with a normal three years of wear and tear. As Consumer Reports puts it, “If you don’t maintain the vehicle in good condition, you’ll have to pay excess wear-and-tear charges when you turn it in.” Natural and man-made forces—including toddlers, for those of you who know—can transform a car that’s pristine off the lot into one that triggers additional fees once you turn it in.
We think leases are a bad idea all the way around, but if you live in a city or have small children, it’s an especially risky prospect for you.
More information here:
How to Get Out of a Car Lease
The most direct way to get out of a car lease is an early termination. While it allows you to walk away from the lease without further obligation, it’s not as simple as saying, “I quit.” Forbes writes, in an article on leaving your lease, “You’ll typically have to pay a termination fee, which is usually the difference between the car’s estimated worth at the end of the lease and what you still owe. This is known as residual value.” It could cost you a hefty sum to do this, especially if you’ve put significant miles on it or it has depreciated in other ways.
There’s another way to escape your car lease—a lease transfer, in which you find someone else to take over your lease for you. Sites like QuitALease.com can help facilitate this, showing a picture of the car you’d like to move on from, the monthly payment, how many months are left on the lease, and how many miles a month you can drive it under the agreement.
Forbes notes that “a lease transfer will likely be a less expensive option compared to breaking your contract as you won’t be subject to early termination fees.” It might cost you a few hundred dollars to facilitate the transfer through a site like this, but it’s certainly less expensive on average than a termination fee.
But You’ll Still Need A Car
So, what should you be spending on a car? Ideally, it shouldn’t be more than you can save up over 3-6 months without getting a car loan. If you’re a doctor making well into six figures a year, you should be able to save up enough to find a serviceable new car or a fancier used car within that time. Since reliable transportation can easily be had for $10,000 (and potentially even $5,000), there is little reason to ever have a car loan of more than $10,000, despite what that content director at The White Coat Investor did.
If you’re thinking about a threshold for what to spend—and you should be—we previously shared this rule of thumb: the value of everything you own with motors (cars, mostly, but also motorcycles, boats, and even planes) should be no more than 50% of your annual gross income. So, if you’re making $80,000 a year, you shouldn’t be looking at a car that costs more than $40,000.
If that doesn’t seem like that much, you haven’t been shopping for new cars recently. Money.com pointed out in a September 2022 article that the average price of a new car is approaching $50,000. That news should incentivize you even more to forget about a car lease and instead look for a good dependable used car—especially if it’s going to require a car loan to finance it.
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