Thursday, February 9, 2012

Lease that fancy car from yourself NOT from the dealer II

I bought that sporty bright blue car with a frog like exterior and four-wheel drive. It responds like a filly and it hugs the pavement in the curves. Perfect for this blogger in mid-life crisis! Very affordable and I am ready to lease from myself. Today’s cars are more fuel efficient than those from four years ago, interest rates are lower. When looking around to replace my trusty Rav4 for which the lease expired, I realized that I can trade the Rav4 in and get some extra mula for down payment on the next lease.

That was when it hit me. When leasing from a third party, I have to pay administration fees, pay back based on their choice of depreciation, and my car use is typically limited to 24,000km per year. Yes, at the end of the lease I can leave the car on the dealer’s lot and pick out a new one with another lease; but I would leave $1000 or $2000 on the table in trade-in value for my old car. If you exceeded allowed car mileage, you will be dinged for that too. Furthermore, the leasing company tells you what insurance you must have and how to maintain the car. Not all of this is bad; it is just that you don’t have any choice. To top it off, they charge interest rates that depend on the car model (believe it or not) and it is often not the best rate. Finally, when you terminate the lease before its term is complete chances are you get hit with a penalty.
So, lease from yourself as I wrote a couple of posts ago. Well, I walked into a dealership, not Toyota’s and they bought my Rav4 for more than the residual value. Since there is today not much room to negotiate on the purchase price of the car that you want to buy, use your trade-in price to negotiate the price of your overall package down. And, with a dealer having the chance to take you away from the competition, they are going to give you a decent price on that trade-in. Where dealers do make money in addition to a new car’s modest mark-up is in the car’s subsequent maintenance and the resale of your trade-in.

So, how do you lease from yourself? Easy as pie! You use a line of credit secured by the equity in your house (LOC or HELOC) or by an investment property you own). Guess what? Now you can borrow money significantly cheaper than the quoted interest rate from the dealership. Neither do you have to buy a car based of their lease terms, because now you set the terms regardless of make and model. Another small saving is that you can also chose a higher deductible on your insurance and thus lower the premium.

So, by ‘leasing from myself’ I get a better rate and terms. But there is more! I also can skip a payment or speed-up the repayment schedule whenever I want and save even more in interest that way. If there is extra cash, just pay down the LOC balance faster and thus lower you total interest costs. You can save a tiny bit of money by paying interest based on the monthly outstanding balance (see left side of table below) or pay fixed monthly amounts (right side).

My new car was about $5,000 cheaper than my Rav4, that combined with the refund from the trade-in and the lower interest rates lowered my monthly payments by $152.00 compared to my old lease. Now that my kids are grown up I don’t need a SUV. The improved mileage of a newer model plus a lighter car saves me another $45 per month. So that is a total saving of $199 per month and  for a 48 month lease that equals $9552 not counting all those other benefits I mentioned before.
Click on the table to enlarge.
If you would like a copy of the real spreadsheet above, just e-mail me. I do not guarantee that it is bug free and you use it at your own risk. Yet, it will give you a tool to better control the terms of your lease and compare the cars rather than the financial terms offered by various dealers.
So, I sat down gloating about my savings and then I got this other bright idea. Making the interest rate tax deductible! That in turn led me to an even better idea. Just continue reading below.
‘Why does a person lease a car?’ I asked myself? Well, when you lease, rather than paying the full sum of the car purchase at once, you pay the lessee only small amounts of cash. That way, you can keep most of the cash for the car purchase in your pocket and use it to invest instead. Hmmm…  That made sense when you could make 10% or more per year in the stock market or 6 to 7% when invested in fixed income. But in today’s market returns on cash are minimal, the bank does not even pay 1% on your money and then you pay nearly half of that interest to the tax man and you lose another 2 or 3% to inflation;heck you actually lose money. So why are you paying interest on your lease or 3% on your LOC balance?

In the meantime, most investors have portfolios that are 10, 15 or even 30% in cash not making anything and losing purchasing power in the process! Use that cash first! And if your ‘portfolio cash’ is used up by your new car purchase and an investment opportunity comes along THEN use the LOC for the investment! Doesn’t that make a lot more sense?  Guess what! If you paid your car with cash out of your portfolio and then borrowed money to invest, the interest becomes… tax deductible. Right on!

It makes sense to lease a car if you can make a high return on investments and cash is expensive. Today, cash is cheap and returns on it are meagre if not negative. So spend your cash on your consumer purchases and use your LOC to finance your investments. BE CAREFUL and DON’T OVERDO IT. Using leverage for investments has its risks! But if you have to choose between borrowing for an investment and borrowing for consumption (your cute little car) then choose to borrow investment money. Is it not strange how over time things change so profoundly that once it made sense to borrow for your car purchase and use your cash to invest while today it is better to buy your car cash and borrow to invest?

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