I've noticed something lately. It seems that we don't own things any more; we lease them. Merchants have discovered that people are perfectly willing to send them money month after month, in some cases even returning the items that the buyers supposedly were paying for! This week we're going to look at the implications of buying something vs leasing it, and we'll see what this decision means for our financial health.
The Fine Print
The articles in this series do not offer specific financial advice. Instead they will present financial tips, with occasional smart-aleck observations and commentary, that may or may not be useful in the reader's particular situation. You should always seek advice from a professional who is familiar with your personal circumstances before acting on any of the information presented in this series.
Back in the Day...
Used to be, people would buy themselves a car (often taking out a loan, which they paid off in instalments until they actually owned the car after a few years). The only time they'd lease a car was when they were travelling. But no longer. Nowadays many people don't buy cars at all; they lease them, making regular payments for a few years and then giving the cars back to the dealer. Then they sign another lease for a different car, repeating the whole process. I know why car dealerships love this arrangement. It gives them a steady, predictable stream of income. Not only that, when the car comes back the dealership can either sell it or lease it again. In effect, they can 'sell' the same vehicle two or three times! So this is clearly a great deal for the dealership. The question is why on earth anyone else would think it's a good idea.
There is an important difference between leasing and buying a car. In the first case, what you're actually purchasing is the use of the vehicle for a specific period of time, not the vehicle itself. There seem to be more and more instances these days in which people make monthly payments and end up owning nothing. In addition to things we've commonly rented, like our flats, electricity and natural gas, these days we've added mobile phone service, Internet access, cable television1, membership at the local gym and such. More and more businesses have discovered that people are willing to pay these monthly 'use' fees. In the US, the on-line business Netflix is currently making serious inroads into the profits of video rental businesses like Blockbuster. Netflix charges the customer — it refers to customers as 'members' — a monthly service fee whether or not the customer actually borrows anything, unlike Blockbuster that charges a fee per film to whoever walks through the door. I'm waiting for someone to try to convince us that we should lease our air, water and food.
The question we're concerned with, of course, is what leasing does to our financial well-being. To figure out who benefits in any financial transaction, watch which way the money flows. The party that is downstream and on the receiving end is the one that generally gets the better end of the deal and the deal gets even better the longer it goes on.
Cost vs Benefit
This isn't to say that someone who rents doesn't benefit or that there aren't valid reasons to choose renting over buying. In the case of housing, a person may want to save up enough money to eventually purchase a house. He may be planning to leave the area in a couple years. He may not want the aggravation and extra work that comes with owning a house. And there are definite benefits to leasing your flat; the landlord is typically responsible for the upkeep and repair of the property and the tenant can pack up and move more easily than he could if he had a house to sell. So even though in the long run it's generally to your financial benefit to own rather than lease, there can be compelling short-term reasons for not buying.
Note that I qualified the previous statement with the word 'short-term'. The expense of leasing starts to outweigh the benefits as time passes. The most obvious example to look at is the leased car. The whole concept strikes me as a way to buy a car on a perpetual instalment plan without ever actually owning the thing. It seems to be designed for those who in the past would have bought a new car every year or two; they actually benefit from the arrangement, as the monthly cost of leasing is less than that of purchasing. For all others who are in the market for a car, I can think of no reason why leasing it would be a good idea other than convenience. When you look at the total cost of ownership vs leasing over a longer period, you'll find that leasing is the more expensive option. The Web has plenty of calculators that allow you to compare the costs of buying and leasing your car. For example, Edmonds.com has an interesting article that compares the five-year costs of buying a new car, buying a used car, and leasing a new car.
In the end, merchants will charge whatever they think their customers will pay, whether or not the price has any relation to the value received. In the case of monthly use fees, we need to take a hard look at the size of the constant drain on our finances and decide whether or not it gives us enough in return. In some ways it's the smaller fees that do more damage. We're all well aware of how much we pay for rent on the flat each month; we wince as we write out the cheque and we may be more compelled to look around in order to save some money. The smaller fees are easier to forget about because they're just a bit here and there; however, they can add up to a significant amount over time. I call it the 'Death from a Thousand Paper Cuts' scenario.
If you find yourself paying too much in monthly use fees, there are ways to reduce them. You should decide if a particular service makes sense in your circumstances. Consider the video rentals I mentioned above. Paying out a monthly fee may make sense if you're a movie buff as it's less expensive than repeated trips to the theatre. If you see a movie only occasionally, you're better off paying a per-movie fee (or — even better — borrowing a video from your local library). Similarly, you may decide that you don't watch TV enough to pay for cable access, but you spend enough time on the Web to make broadband access worth the cost. And there are mobile phone plans for everyone, from the person who wants it for emergencies only to the person on-the-go who spends his life on the phone.
My personal rule is to always weigh the cost of goods or a service against the value of those goods or that service and to decide if it's worth it. I also try to eliminate the small monthly expenses that are so easy to ignore. And I'm wary of any sort of subscription that renews itself automatically, forcing me to take action to cancel the service. Businesses like this opt-out model, as people are likely to just let things slide (and continue spending money on something they may not actually use). I don't avoid such things entirely, but I decide ahead of time if I'm likely to want to continue using the service and I check to see just how easy it would be to cancel should I want to. I allow my anti-virus software to automatically renew its subscription each year, but just last week I changed my mind about subscribing to an interesting-looking financial Web site because it uses the opt-out model for renewals and the cancellation process wasn't obvious or intuitive.
As with all things financial, there is no right or wrong answer to the lease vs own question. In the long run, leasing is almost always more costly than owning, but there are exceptions to this rule. For example, a person may buy a house in a 'hot' housing market where prices are rising at an unrealistic and unsustainable rate. If the person takes out a very large mortgage and housing prices should suddenly fall back to more reasonable levels, he may find himself owing more on his mortgage that the property is worth. While this isn't common, it's something to be aware of if you're considering buying a house and it may affect your decision on whether to buy or continue to rent. In the end it's up to each of us to consider our personal circumstances when we decide that the benefits of leasing a particular item is worth the additional expense it entails.
Looking to buy a house? Check this Rent vs Own Calculator from Yahoo Real Estate.
Another discussion on To Buy or to Lease? from Cars.com.