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The age-old question: Should I lease or buy a car?
The short answer: Smart money buys 2- to 3-year-old used cars (letting someone else eat the bulk of the car’s depreciation) and keeps them for 3–5 years, while the car is still under warranty and retains a decent resale value. But let’s answer the question in more detail.
Buying vs leasing a car is mostly a financing question. To unpack that a little, you’ll need to swan dive into these: whether it will be cheaper in the near term or long term; whether you can afford the monthly payments; and whether you can get a loan.
In addition to determining what options you can afford within your budget, you must ask, ‘What’s the best use of my money?’
But to answer that question, let’s examine two important financial concepts: 1) the time value of money and 2) opportunity cost.
The time value of money states a dollar today is worth more than a dollar tomorrow. You want to hold on to your dollars as long as you can, deferring payments and accelerating receipts. This is why it’s actually better to owe money on your tax filing rather than get a tax refund. The latter is an interest-free loan to the federal government. Nahhhht for me.
Opportunity costs are the lost potential gains from alternative options. For example, five years ago, you could have placed $1,000 cash into your checking account (or mattress), which earns 0%. Today, you would have $1,000.
The opportunity cost of hoarding cash in a bank account is the lost gains you would have made, say, investing in stocks. If you’d invested $1,000 in June of 2013 in an ETF that tracks the Dow Jones Industrial Average, today, you’d have about $1,620. The difference — $620 — is your opportunity cost. (Opportunity costs exist for every decision you make, economic or noneconomic.)
Because four-door Jeep Wranglers are objectively the coolest, here’s the setup: new Wrangler Sahara at $37,000 MSRP — lease it or buy it?
Buying a car
Buying isn’t always the ideal, and buying cash (i.e., the full purchase price up front) isn’t always better than getting a loan and paying over time.
If you had the cash on hand, you could walk into the dealer, drop some stacks, pick up the keys, and cruise. But remember the concepts from above: although you’ll pay $0 in interest, you’ll instantly (time value of money) be without $37,000 to invest and not earning that juicy 62% return (opportunity cost) over the last 60 months I mentioned above.
Even setting aside the opportunity costs, buying a car is almost always more expensive in the near term.
First, remember that sales tax is a thing. When you buy a car, you pay tax on the entire cost of the vehicle. On that Wrangler Sahara, Uncle Sam will tack on almost $2,600 in sales tax. That’s real, Ladies and Gentlemen. And you’ll pay all of it whether you pay cash or finance it (i.e., get a loan).
Second, loan payments will typically be higher than lease payments. This also makes buying more “expensive” than leasing in the near term. Many leases are structured to be more attractive (cheaper) than loan payments over the same period. But lest we forget: once the car is paid off, your monthly payment drops to $0, and you own an asset with a resale value in the thousands or tens of thousands. (At the end of a lease, you owe the dealer a car.)
Some pros of buying: owner rather than renter, cheaper over long term, and no restrictions on use or customization.
Some cons of buying: you’ll be responsible for post-warranty maintenance and repairs, you need higher credit to take out a loan, you pay full sales tax, and it’s more expensive in the near term.
Leasing a car
Like the analysis of buying, the leasing analysis is kind of a mixed bag of pros and cons. It’s not always better than buying, but it’s not always worse.
The lease corollaries to the pros and cons of buying are:
- Leasing is cheaper in the near term
- You don’t need as great credit to lease
- You don’t get anything out of it at the end
One huge component of car leases is the mileage restriction. Typically between 9,000–15,000 miles per year, the lease will permit only a certain number of miles on the car before you have to pay heavy per-mile charges (like 20¢ per mile). If you don’t drive much, this won’t matter to you, but if you drive a lot, this can break the deal.
Also, leasing has a twofold tax benefit compared to buying.
- When leasing, you usually pay sales tax on only a portion of the vehicle (e.g., if you leased the Wrangler for 3 years, you would only pay about $700 sales tax on the $10,000 of value you’d pay for in lease payments).
- If you own a business that needs a car, you can deduct parts of the lease payments on your taxes, which you can’t do with loan payments if you were to buy.
One last thing to remember — if you don’t own the car, you might be restricted in how you customize or use the car. You may be prohibited from driving for Uber or Lyft.
Some non-quantifiable considerations
1. Newness of the vehicle
Leases generally lend to higher turnover.
But it’s not just the newness factor that causes some people to want a new car every few years. At this point along the innovation s-curve, safety and convenience features from AI and Level 5 autonomy are speeding (bad pun — sorry) toward us. If you lease a car, you might be able to level up in safety and convenience sooner than if you buy.
With all-electric and fully-autonomous vehicles coming down the pike (sorry, again), you could argue that it’s better to trade in your two-year lease for cars that are 10x better than the previous one, than it is to have a purchased car and kept it for 6 years, which is now 1000x worse than the new cars of today.
When you lease a car, you get a new car at the beginning of its warranty, so there’s lower maintenance and cost.
Also, at the end of the lease, you don’t have to worry about selling your used car. You just drop it off and walk away.
Then, something I, myself, am only just learning to really place a fair value on is the cost of the hassles…
I’m inclined to “maximize” every decision, which means calculating all the variables to determine the lowest total cost of the car, then doing that thing despite the loss in earning capacity for the time I spent figuring it out, the stress caused by plus-70,ooo-mile-vehicle maintenance and repairs, and the bother of selling it for the best possible price but still feeling like I took a bath (or haircut — or whatever your preferred hygiene analogy).
And the more I protect Future George from hassle, frustration, and mental computation, the more time I can spend in flow, like this dude, doing all the things (← that’s a link to something you’ll be glad you clicked).
Making the decision
This analysis does assume new cars in both situations. But you can buy used. The first couple of years chew up the steepest part of the depreciation curve. So you could buy a 3-year-old car, for example, keep it for a few years, and still sell it with decent residual value remaining. This is what I’ll be doing.
In the end, buying or leasing a car is mostly a financing decision: Which option will make the best use of your money?
No matter which option you deem best, one thing to remember is that both leasing and buying a car helps build credit. So there’s a high-five!