By FPA member Michael Krol, CFP®, CPA
Last Updated: June 1, 2010
You have done all the hard work and fun research. You have picked out the color, make and model of your dream (or at least next) car. You have negotiated the best price. But next comes the one question that you may not be ready for: "Will you be leasing or purchasing this vehicle?"
At this point, one side of you is undoubtedly attracted to the lower monthly payment of the lease. But the other side of you remembers always hearing that buying is the more responsible decision. As with most other financial decisions, there is no single "right" answer for everyone. The answer for you is…it depends.
Lets look at some of the differences between the purchase and lease option.
A vehicle purchase will require either an upfront payment for the full purchase price or financing arrangement in which the full purchase price and a finance charge is paid over a number of months. Either scenario will also be subject to a sales tax (if applicable in your state).
A lease will consist of monthly payments of the expected decrease in value of the vehicle over the term of the lease (also known as depreciation), a finance charge and a lease tax (if applicable). At the end of the term of the lease, you have an option to purchase the vehicle at the residual value (the purchase price less the depreciation paid over the term of the lease). This purchase could potentially be financed and is generally subject to sales tax.
In most any scenario, a lease will initially be the less expensive option for a given period of time. However, if you are continually leasing vehicles, those payments will continue indefinitely and eventually exceed the cost of purchasing or financing the purchase of a vehicle. So the question then becomes: "How long do I have to keep a vehicle for a purchase to make more sense than a lease?"
There are numerous factors that are involved in calculating "How long do I need to own it?":
- The rate and manner which the vehicle's value decreases,
- Lease and purchase financing rates,
- Lease fees,
- Inflation of vehicle prices,
- Vehicle maintenance costs, and
- The fact that, all else equal, it is better to pay a dollar in the future than it is to pay a dollar today.
Because of all of the variables that influence the answer, it becomes apparent that the answer is different for every vehicle at any given point in time. However, in an analysis of a number of different lease arrangements, the general answer was that a purchaser would have to own the vehicle about one and a half lease terms for purchasing to make more sense than leasing. In other words, if the offered lease term was three years, the purchaser should be willing to commit to owning the vehicle for more than four and a half years, otherwise a lease is the better option.
There are some instances in which the leases offered by certain dealers are significantly worse than average. The only way to really identify these is to run the numbers (also known as a present value analysis), but these generally seem to pop up for vehicles in which leasing is in high demand. In these situations, the dealers will pad their profits because they know people will lease even if purchasing is a much better option (e.g. some low end luxury vehicles).
An interesting alternative, which can make sense in many situations, involves leasing the vehicle and then subsequently purchasing it at the end of the lease at the "buyout" value. From a financial perspective, the total cost of the lease-buyout usually ends up being comparable to purchasing the vehicle. However, this option affords a great deal of flexibility in both your future finances and relative to the future value of the vehicle. You should keep in the mind that this option will require a lump sum of cash available at the end of the lease (or be subject to less advantageous used car financing rates).
In making your final decision, here are a few considerations to keep in mind.
If you are going to lease:
- Understand that, over the long-term, purchasing a vehicle and keeping it for a long time will likely result in a better financial outcome.
- Look for a car that holds its value well and see if a longer lease term with a lower payment is available.
- DO NOT lease as a means to get a car you cannot afford.
- Strongly consider purchasing the vehicle at the end of the lease.
If you are going to purchase:
- Commit to owning the vehicle for (generally) more than one and a half times the length of the offered lease.
- Consider a lease with a subsequent buyout as a financially viable alternative that affords additional flexibility.
- Understand the expected maintenance costs for the vehicle later in its life (higher relative costs mean a lease becomes more advantageous).
One other important item to note as part of any vehicle acquisition: You may have noticed in the first paragraph that negotiating the best price came before the decision to lease or buy. In auto negotiations, it is best to first negotiate the total purchase price of the car and then see how the lease and buy options fall out. The price inherent in a lease is negotiable.
FPA member Michael Krol, CFP®, CPA, is a Senior Wealth Counselor with Waldron Wealth Management.