Is It Better to Buy or Lease a Car? The Surprising Answer.
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Updated on October 20th, 2021
Is it ever a good idea to lease a car?
Contrary to all the gurus that say that you should never lease a car, leasing a car is actually functionally equivalent to buying a car. When you lease a car you are paying only for all the depreciation (and interest) that the car will endure over the lease term. If you buy the car either outright or with a loan on the new car, you would still endure the same depreciation regardless of your financing choice. If you were considering buying a new car anyway, then leasing is something you should definitely consider after reading this article.
Before buying my Aston Martin I did consider the prospect of leasing a sports car to minimize my outlay of upfront cash. However, in the end, I decided to sell stock and pay cash because of my fears of a stock market bubble. There are pros and cons to leasing a car and while it won’t make financial sense for everyone, we will answer why leasing a car is smart in some circumstances.
There Are Three Major Advantages To Leasing a Car
Suze Orman and her ilk love to say “never lease because when your lease term ends, you don’t have an asset!” Yes, that is true, but a lease also has monthly payments about half what it would be to buy, and extra money is an asset in itself. As long as you do something smart with your savings, like investing, then you can end up in a better position.
Tax Benefits of Leasing a Car
This is less widely known or considered but can easily end up being worth thousands of dollars. When leasing, you only pay sales tax on the difference between the sales price and the retained value. In other words, you pay approximately half the sales tax you would otherwise from buying. This is a huge advantage.
Furthermore, if you use your car for business purposes, the lease can be written off as a business expense, whereas an outright purchase would be considered a capital expense.
At the end of your lease you have the option to give it back or to purchase it. That is a valuable option since the car may have depreciated more or less than expected at the time the lease was signed and you don’t have to engage in a sales process to get out of it. After driving it for several years you may find out that you just don’t like the car, or you might be ready for the latest model.
When Leasing a Car is a Bad Idea
The time that leasing a car will get you into trouble is if you decide to get a more expensive car than you otherwise would have. Don’t make the decision that because a lease payment is half the cost of buying that you can then lease a car that is twice as expensive. That decision won’t do you any good.
The decision to lease should be about spending less money, not lifestyle inflation. Your barometer should be if you can comfortably afford the full car payments for a purchasing auto loan. If you can’t, you should choose a cheaper car. Also, you should be putting those car payment savings into an investment, not buying more crap.
Are You Perpetually Leasing?
The second reason of when you shouldn’t lease a car is if you’d rather keep it for a very long time and spread out the cost of the auto ownership.
Leasing a car time and time again is functionally equivalent to buying and selling a new car every few years in perpetuity. Doing this repeatedly will end up costing you more money in the long run because the depreciation is steepest in the first few years. Ask yourself if you would buy a new car every 3 years and then sell it for a new one taking a depreciation hit each time? If you are comfortable with that idea, then go for it.
One avenue to help with that problem is to extend the lease term. The typical lease is 3 years, but some do go out to 5 years. Generally car dealers don’t like to lease cars longer than that because if the car is no longer under warranty and it breaks down, the lessee might just walk away. Then the lessor is on the hook for the repossession and fixing the car. But for you, extending the lease term can be a smart move to diminish the depreciation that you’ll be paying over time.
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The third reason why you should not lease a car is if you drive a lot of miles every year. All leases come with mileage limitations and if you cross the limit, you’ll face stiff penalties. You can negotiate these to a higher limit, for a cost, of course.
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You can’t make permanent modifications to the car. Even simple enhancements such as window tinting can cost you at the end of your lease term. The dealership might even keep the tint on the car, but they’ll charge you to remove it anyway.
What To Consider When Leasing a New Car
You still need to make sure the lease deal makes sense. Is it better to lease or finance a car? It depends on the deal. Buying or leasing won’t always be better if the terms are stacked against you.
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Car Price (aka the Capitalized Cost)
Most people hate haggling over the price of a car, but unfortunately you still need to do it even if leasing. Lease payments are based off the difference between the negotiated ‘sales price’ and the book residual value at the end of the lease, so the negotiation tactic is the same for buying or leasing. You can try to negotiate both values, but there will be more resistance to adjusting the retained value figure than the sales price, since car depreciation data is well documented.
Know The Interest Rate (aka the Money Factor)
When you lease you can think of it as buying half the car… the depreciating half. Your interest rate will influence your payment amount somewhat, but to half the extent that buying would. It’s still important to be aware of what interest you are paying and whether or not it is a favorable deal, however.
For some reason, leases are not quoted with interest rates, but instead are quoted with “money factors.” Why? APRs are not required by law for leases and likely because the number is super small on the paper and it confuses people leasing into thinking that they aren’t paying much interest. Multiply that number by 2,400 to find the APR.
2400 is derived from ½ the principal, 1/12th the payments, and 1/100th the interest rate. 2*12*100 = 2400. Convoluted, I know.
Minimize the down payment
Since your lease payments are paying off the car’s depreciation, and cars will lose about 10% or more driving them off the lot, you should try to minimize your down payment. If your car is totaled in an accident shortly after you lease it, you won’t get that down payment money back. Your insurance will pay the lessor and you’ll be out of luck.
If you can pay nothing up front but pay a little more interest, it is a likely favorable tradeoff for the risk.
Match the lease term to your time line
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If you need a car for a commute but are planning on moving into the city next year and can take the subway, it won’t do you any good to have a car sitting in your garage collecting dust for 2 years. Just because a typical lease is 36 months, that doesn’t mean you have to go with it. Choose a term that matches your timeframe.
Auto dealers love to ding you with one more gotcha and will often charge you a disposition fee that you pay at the end of your lease when you return the car; it can be a considerable cost. Since you don’t have to pay this fee upfront, you may not think much of it, but your future self will thank you if you negotiate that fee now before you sign.
Lease a Used Car (optimal solution)
Because cars lose about half of their value within the first few years, and that is what your lease payment is paying for, the optimal solution is to lease a used car that is already 3 years old, if you can find a servicer for it. Your payment will be about half a new car lease, or a quarter of a new car financing loan, and your insurance cost will be lower. Furthermore, it will still look like a new car to most people anyway.
Leases on used cars do exist, but they aren’t commonly advertised because they aren’t as profitable because the ‘loan balance’ is much smaller and automakers subsidize and underwrite the leases on their new cars to push product. Ask your dealership if they offer it, but make sure it is answered by the financing department because the salesmen either might not be aware of it or will steer you away from it to enhance their commission. A simple search online will reveal some services that offer these used car leases as well.
You won’t get the new car smell or all the latest gadgets and you might have slightly higher maintenance costs, but you’ll be saving half the payment every month. With reliability of cars today, the servicing costs shouldn’t be much more than what it would be for a new car anyway.
It is basically common knowledge that paying cash for a used, well maintained car and driving it for 10+ years will be the cheapest route in the auto ownership equation. But not everyone wants to, or is able to go that route.
Is leasing a car a good idea? It can be.
Leasing a new car will be more expensive if done in perpetuity, but for those who have accepted that fact, or plan on leasing a car only a few times in their life, it is an easy way to enjoy the luxury of a new car every few years without having to deal with the hassle of selling their used car. And you always have the option at the end of your lease to buy the car at the agreed upon residual value if you really like it.
The truly optimal solution for minimizing one’s cash outlay on a vehicle is to lease used cars. You won’t eat as much depreciation as a new car lease, your payments will be much lower than a typical auto loan, and you’ll still have the flexibility of changing to a different car at the end of your lease term.
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