Today we’re taking a look at the age-old question of whether you should lease or buy a new car.
On the one hand, many people say that you should never lease a car since you don’t own anything. Furthermore, in the long term (7+ years), you will likely spend more on a lease than you would if you had bought the car.
On the other hand, a car is a heavily depreciating asset so why not lease it? The lease payments you make in the first few years will likely be less than the amount that the car depreciates by.
We would like to help you make the most informed decision possible. First, we’ll go over what buying and leasing involves, and then go into what situations favor one method over the other.
By the end of the article you’ll know whether leasing or buying a new car is right for you!
Buying a New Car
In this scenario, you purchase the car outright. You can either finance it or pay for it all with cash.
You go into the dealership, negotiate your best price, and pay for the car. When you pay cash for a car you tie up your money in a depreciating asset, but you are now the sole owner of the car (which is a nice feeling).
If you buy with a loan, you don’t tie up your money all at once, but you pay more because of finance charges – which is money down the drain in addition to the depreciation losses.
With loan interest rates that are typically below 2% (if you have a decent credit score), we would recommend financing the car rather than paying for it all with cash. You can put your cash in a high interest rate savings account and easily earn more than 2%.
Leasing a New Car
In this scenario, you are essentially renting the car from the dealership for a specified amount of time – usually three or four years.
You go into the dealership, negotiate your best price, and come out with a monthly lease payment. The lease payment is basically paying for the depreciation of the car plus financing charges. At the end of the lease, you return the car to the dealership and don’t own anything.
It’s natural to question leases since the dealership tries to make negotiations very confusing by tossing around terms you have never heard of. They are betting on you being too lazy to try and understand what they’re saying, and just focusing on the monthly payment.
Here are some of the key terms you will have to be familiar with before walking into the dealership.
MSRP or Sticker price: The full retail price of the vehicle that is shown on the window sticker at the dealership. This number is set by the manufacturer and won’t change.
Money Factor: This is the interest or financing rate for the lease. Just to make it confusing, the dealership quotes this in five decimals (e.g. 0.00020) rather than an annual interest rate. The more common annual interest rate can be determined by taking the money factor and multiplying it by 2,400.
In the example, a 0.00020 money factor is the same as an annual interest rate of 0.48%.
The lower the money factor, the better it is for you!
The money factor is typically set by the manufacturer’s corporate office so the dealership won’t be able to do much to change this. You’ll have to research different manufacturers to see what their money factors are.
As an example, we sent our intern Jaime (sorry Jaime!) to the local Audi dealership to see what their current money factor is. They came back with a 0.000824 (or 1.98% interest rate).
This is actually a very good money factor, as anything that starts with “0.000” (or triple zero) is excellent.
Residual Value: The dollar amount the vehicle is worth at the end of a lease. This is usually quoted as a percentage (%) of the MSRP. For a three year lease, the residuals will usually vary between 40% and 60%.
For example, if a car has an MSRP of $40,000 with a 60% residual, then residual value will be $24,000.
The higher the residual value, the better it is for you!
The residual value is also set by the manufacturer’s corporate office so the dealership can’t really discount this. As an example, the local Audi dealership had a 48% residual value for a four year lease.
One odd thing to note about residual values is that additional options don’t increase it. For example, if the car’s MSRP is $40,000 and you add in $5,000 worth of option (bringing the total purchase price to $45,000), the residual value is still only based on the base MSRP of $40,000.
Lease Term: The duration of the lease in months – usually 36 or 48 months. We would recommend getting a lease term that is the same as the warranty period of the car.
Negotiated Sale Price: This is the agreed upon value of the vehicle. While the MSRP or sticker price will never change, the negotiated sale price will change depending on how well you negotiate.
This is your time to shine and see how much you can beat the dealer up on the price!
Other factors: There are other factors in the lease such as the Gross Capitalized Cost, Capitalized Cost Reduction, and Rent Charge. However, it’s not as critical to understand them to get a good deal as they’re fairly straight forward.
Key Takeaway: If you want a low lease payment, then what you have to do is focus on manufacturers that offer the highest residual value, the lowest money factor, and getting the lowest negotiated sale price from the dealer.
You now have a monthly lease payment, and you have to return the car at the end of the lease in reasonable condition. The dealership will charge you to fix up big dents, scratches, and stains upon the return of the car.
When is leasing better than buying?
In almost all situations buying will be less expensive than leasing. The reason is that once the car is paid off, you essentially pay nothing to own the car save for maintenance. With a lease, you’re always paying something to the dealer.
However, there are some circumstances where leasing is better.
1. You have a business that you can write-off the lease payments against.
This can be any type of business that is recognized by the tax authorities. Some examples include:
- Consultant (eg. you need to drive to meet clients)
- Rental Property / AirBnB (eg. you need to get to/from the property to perform maintenance)
- Photographer (eg. you need to get to your location to take photos)
Everyone’s tax situation is different so we can’t make any generalizations here. We would encourage you to engage with a tax accountant (or post your situation on Reddit – which we have found surprisingly helpful) to see if these write-offs are worth it for you.
Having a lease payment makes the tax deductions much simpler when compared with having to do a capital cost depreciation. Since lease payments are lower than financing payments, leasing might end up being cheaper depending on how much of the payment you can write-off when doing your taxes.
2. You’re buying a luxury car that you don’t want to roll the dice on with expensive maintenance.
Everyone has heard horror stories about their friend’s BMW/Audi/Mercedes blowing an engine gasket at an inopportune time and racking up a huge repair bill.
Huge repair bills are one way where buying the car outright will cost you more in the long run when compared with leasing.
Since you’re generally covered by the manufacturer’s warranty during the lease period, you don’t have to worry about massive unexpected repair expenses.
Why do car dealerships push leasing?
If leasing can be a good deal, then why do dealerships push it? In general, anything that is a good deal for the dealership is bad for the consumer.
One of the biggest reasons is repeat business.
Consider a situation where you buy the car outright. How likely are you to be back at the dealership in 48 months looking for a new vehicle? The chances are pretty low – and if you are then you would’ve saved more money leasing rather than buying the vehicle!
The car salesman makes the same amount of money whether he sells or leases the car to you. He would much rather have a repeat customer who comes in once every few years to lease a new car than having someone he sees once every ten years.
Leases also give the dealership a steady stream of good used vehicles that they can sell to other customers.
When it comes to new cars, most people will find that buying the car and driving it for 6+ years will be a better financial deal than leasing. However, we encourage you to run the numbers for yourself – especially if you have a side hustle that you can write your lease payments off against.
If you’re all about maximizing your savings, then you should buy a used car that is 1-3 years old. This is pretty much the best financial deal you can make for yourself when it comes to a vehicle.
The final thing we would like to mention is that your vehicle expenses should never exceed 10% of your pre-tax income. If you make $4000 a month, then your car expense (whether it be financed or leased) should be less than $400.