Buy versus Lease Part 1

If you spend any time reading personal finance books, websites or blogs, you will quickly see that buying a car outright, in fact a reliable used car, is considered favorable to leasing a car.  I have always believed this to be true, but have never done the math.  So, last night, I took some time to research how lease payments are calculated and the tax treatment if the vehicle is used for business purposes.  Lease payment calculators are available online, but none of them breakdown the math involved.  Believe me, understanding the math is critical in not getting screwed if you plan to lease.  You can check out my buy vs lease calculator.  It may need some work, but it definitely does the math.

The results are complicated because there are sooo many variables.  For example, higher interest rates favor buying, while shorter loan/lease terms favor leasing.  Lower down payments favor leasing, while the ability to deduct a portion of your mileage from income taxes favors buying, unless the vehicle is used for small business purposes.  Fairly obvious, if you keep the purchased car for a few years longer than the loan/lease term, you come out WAY ahead.  That, to me, is the biggest benefit to buying over leasing.

But to get the argument for leasing, I found a site called leaseguide.com.  Their article on lease vs buy was clearly slanted to the leasing camp.  Not a big surprise considering they are a site dedicated to selling a "lease kit" for twenty bucks to help you make a good deal on your lease.  I took their article on the benefits of leasing, and respond to each of their points below.

Each bullet point is one of the "benefits of leasing" according to leaseguide.com.  My response follows in italics.

• Lower Monthly Payments. 

True, you can get the same car for lower monthly payments. Unfortunately, the way most people use this is to get a more expensive car for the same payments.  For example, someone on a Honda budget thinks they can get a BMW because they can afford the lower lease payments.  That person would be far better off financially to get the Honda.

• More Car, More Often.  Since your monthly payments are lower, you get more car for the same money and drive a brand new vehicle every two to four years, depending on the term length of your leases.

They are making my point from the "benefit" above.  If you really are a car junkie and need to have a car every two to four years, then leasing is the way to go.  But know that unless you make A LOT of money, this is a sure way to keep you from ever being wealthy.  Besides, if you are getting more car, more often, you're not really getting lower monthly payments, are you?

• Fewer Maintenance Headaches.

This one is just silly.  If you are that worried about the cost of maintenance you should buy the manufacturer's extended warranty.  But, you probably shouldn't do that either, unless you are getting a "certified pre-owned" car.  Then it might make sense.  But that's a topic for another post.

• Lower Upfront Cash Outlay.Most leases require little or no down payment, which makes getting a new car more affordable and frees up your cash for other things.

Sadly those "other things" are rarely saving or investing.  Regardless, if low upfront cash outlay is a big concern, I assure you that you can purchase a 2-3 year old car from the dealer with very little down.

• Lower Tax Bite. In most of the U.S. and in Canada, you don't pay sales tax on the entire           value of a vehicle when you lease. You're only taxed on the portion of the value that you use during your lease. The tax is spread out and paid along with your monthly lease payment instead of being paid all at once.

I suppose this one is true.  I don't know enough to say otherwise.  So, it sounds like you would end up paying about half of the sales tax in most cases.  Depending on your local sales tax rate, this one would save you 3-4% over the life of a 3-4 year lease. 

A very common misconception is that leases are better for business purposes because of the tax write off.  I will address that in a follow up post because that is a sales tactic that is rarely understood, and a big pet peeve of mine.

•  No Used Car Hassles.With leasing, the headaches of selling a used car are eliminated. When your lease ends, you simply turn it back to the leasing company and walk away, unless you decide to buy it or trade it.

Right, you don't have the hassle of a paid for car that you can drive without any monthly payments for another five to ten years or more.  Paid off used cars sure are a hassle.  Seriously, this one is absurd.

• Gap Coverage Included. Most leases automatically include free "gap" protection in case your vehicle is totaled in an accident or stolen, and you still owe more than the vehicle is worth. Loans do not.

I have an answer for this one.  It's kind of complicated, and most people won't understand what I mean.  But I'll give it a try.  Don't borrow so much to buy your car that you will end up upside down.  Okay, I know.  I don't mean to get technical on you.  The words, "don't borrow so much" don't make a lot of sense.  But here's the deal.  Gap coverage is only necessary if you owe more than the car is worth.  This only happens if you put little to no down payment and/or stretch the term of your loan excessively long (five years is too long people!).  And it most commonly happens with new car purchases because of the significant depreciation in the first year.

Comments

[frank]

5 years isn't too long :P
Ordinarily, I would agree. However, in my case (we have a five-year loan) the interest rate was the same no matter the term (3, 4, or 5) and I figured, why the hell not. It's under 5% and we plan on driving the car for at least that long anyway.

[franky]

Oh, and to comment on the actual substance of your post:
Excellent analysis. I am not a car person at all and just do not get it when it comes to some of my coworkers. This one guy recently bought a $30,000 Audi. Brand new.

[Brendan]

What if you plan to get a new car every two years? Still better to buy? (Let's assume you can buy the new car in cash, but also seperately assume that you can't and you'd finance the new car). It may be a dumb financial way to live, but many people do this because they need the latest thing.

Successful Personal Finance.com

[mun]

"I am not a car person at all and just do not get it when it comes to some of my coworkers. This one guy recently bought a $30,000 Audi. Brand new."

Exactly you are not a car guy. What do you spend your money on???, I am sure you have your pet peeve. Sounds to me you are jealous of the guy's AUDI. Maybe you should get one. Keep on stashing all your money for tommorrow and buy the audi (or whatever) when you are 70, if you make it. Live today, plenty of time to die later.

[Ryan]

"when you are 70, if you make it. Live today, plenty of time to die later."

If you dont save today, you definitely wont have much to look forward to at 70. Hope you like your car.

[Andrew]

I crunched the numbers for a buy/lease decision on a BMW 3 series. I evaluated buy vs lease over six years, so two 36 mo leases or one 60mo loan. I came out with the lease as only 1500 more and I think this premium is worth it to get a new car in three years. The great thing about BMWs is the free maintenance for the first 4 years/50 miles. So with the lease I have zero maintenance cost over 6 years. With the buy decision I had to estimate the extended warrantly and maintenance costs. Another thing I noticed is the lease becomes more attractive as your estimated rate or return increases. This is because the residual value gets pummeled with a high rate of return, and also the 6th year of lease payments in present value is lower. So in short lease mitigates a lot of risk in exhange for a slight premium. The risk in the lease is that you don't use all the miles, or go over at a high mileage rate.

[zhafran]

Buy or lease for a new set of wheels? Each option has its own benefits and drawbacks, and it all depends on a set of financial and personal considerations.

Your finances is clearly key, and you need to ask the question of how stable is your job and how healthy is your general financial situation.

The short-term monthly-cost of leasing is significantly lower than the monthly payments when buying: you only pay for “the portion” of the vehicle’s cost that you use up during the time you drive it.

Buying effectively gives you ownership of the car and that feeling of “free driving” that goes on providing transportation.

Unlike buying,leasing gives you the option of not having to fork out the down payment upfront, leaving you to pay a lower money factor that is generally similar to the interest rate on a financing loan. but terminating a lease early or defaulting on your monthly lease payments will result in stiff financial penalties and can ruin your credit.

Besides the financial aspect, making a buy or lease decision depends on your own particular lifestyle choices and preferences.

If you want to drive a car for more than fives years, negotiate carefully and buy the car you like. If, on the other hand, you don’t like the idea of ownership and prefer to drive a new car every two to three years then you should lease.

Next, factor your transportation needs: Leasing is based on the assumption of limited-mileage, usually no more than 12,000 to 15,000 miles a year, and wear-and-tear considerations. Unless you can keep within the prescribed mileage limits and keep the car in a good condition at the end of your lease, you might incur hefty end-of-lease costs.
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