This dilemma invites anxiety into our lives every time we are in need of a new vehicle. In this article, I’m going to explain how to conduct a breakeven analysis on buying versus leasing a car while considering transaction costs, financing, and taxes. There are a number of calculations in this article, so I’ll remind my clients now that I am happy to help you with this type of analysis, or with any major purchase.
For purposes of this post, let’s assume that you are going to purchase a new Acura for $35,000. The dealer gives you two options:
- Lease the car for four years for $484/month with no down payment
- Buy the car with a four-year loan from Acura and pay $950/month
First, Know This – Cars Are Wasting Assets
Cars are a terrible store of value. Unlike a house, they lose value quickly after purchasing one. Based on a few different sources, the average depreciation rate for a new car is 20% in its first year, and 15% each year thereafter while used cars simply lose 15% of their resale value each year. Why is depreciation bigger in that first year for new cars? It’s because as soon as they are bought, they turn into, here comes that ugly word, “used” cars. That’s why you can find used cars with under 5000 miles on them with major discounts – they can’t be resold as “new” even though they are likely as good as new.
Since cars are a depreciating asset, that means they lose value each year from obsolescence and wear. Therefore, by simply owning a car, the amount of dollars it falls in value each year is a monetary loss.
Like I said, cars are terrible stores of value, which is why if given the option of buying a more expensive home versus a more expensive car, I’ll take the more expensive house any day.
I digress. The reason why these facts about depreciation are important is because the argument that “leasing is throwing your money away” doesn’t hold much water here because when you buy a car, you have also thrown money away as a result of depreciation.
Step 1 – What’s My Residual Value?
“Residual value” is the term accountants use to determine how much an asset is worth after factoring in depreciation. In this case, we want to know our Acura’s residual value following a lease and a purchase. For a lease, it’s easy. Since we have to return the car, it will be zero. For our purchase, we need to do a quick calculation.
- The new purchase price was $35,000
- In the first year, it lost 20% of its value, so $35,000 becomes $28,000
- In each year after, it loses 15% of its value, so $28,000 becomes $23,800
- In thethird year, $23,800 becomes $20,230
- And finally, after the fourth year, when we paid off our loan, our car is worth $17,196
$17,196 is our residual value for our hypothetical purchase. Of course, you can get very accurate with this by looking up the depreciation rate of your specific vehicle model. For instance, Subarus and Porsches have a lower depreciation rate than, say, Fords. Kelley Blue Book offers a lot of good information on this, if interested.
Step 2 – Breakeven Analysis
With our crucial residual value on a purchase, we can now run a breakeven analysis. I’m going to do a simplified method, which does not take into account opportunity cost. If you are interested in such an analysis, give me a call and prepare for your eyes to glaze over.
Let’s dive in.
Purchase:
- $850/month pays the car off in four years
- That’s 48 monthly payments, totaling $40,800
- Your residual value of the car after four years is $17,196
- So, your cost of ownership for four years is $40,800-$17,196=$23,604
- Remember that cost, $23,604
Lease:
- $484/month allows you to lease the car for four years
- That’s 48 monthly payments, totaling $23,232
The result in this example is that leasing is cheaper over four years by $372
Step 3 – Fiddle With Financing
It’s always worth it to consider what lending options you have besides dealer financing. Dealer rates, absent any sort of promotion, tend to be relatively high versus a non-profit credit union. Normally, the dealer will tell you what your rate is when you purchase the car, I left it out in this example up until now on purpose. In this case, I assumed a very low promotional rate of only 0.67%. You probably won’t be able to find a lower rate than this often.
However, if you feel like your rate is high, it always makes sense to shop around with local banks and credit unions to see if they will finance or refinance your car after you purchase it.
Step 4 – Consider Transaction Costs
When you purchase a car, your receipt will include all sorts of transaction costs, including dealer fees, lease-acquisition fees, title fees, and sales taxes. These fees are incurred each time you transact. Therefore, buying and selling cars less frequently saves you money. When you return your car after a lease, you will need to lease or purchase another car, incurring more transaction fees. This is the same case if you decide to trade in a car you purchased.
If you purchase a car with the intent of “running it into the ground” over several years or more, purchasing will often become more appealing because you avoid having to pay transaction fees every few years.
Final Step – Tax Write Offs?
This step does not apply to most of us, but if you are using your car for running a business, you can deduct the cost of your car. For leases in which the car is used solely for business purposes, 100% of each lease payment can be deducted. If you purchase a car, you can deduct your car’s depreciation and the interest on your loan payments. Because of this, tax benefits of purchasing a car tend to be front-loaded while benefits of leasing a car tend to be level. For business owners who just had an extremely profitable year, purchasing may make more sense from a tax perspective. You would want to speak to your tax preparer, but you may be able to take a large tax deduction called a Section 179 deduction.
Buy vs. Lease – I Prefer Buying But it Depends
My personal opinion favors buying, since the lower payments with leases give the illusion of being able to afford more “car” than you can. However, the decision to purchase or lease a car depends on many factors. Ultimately, it comes down to a breakeven analysis, with the major factors being the transaction costs, depreciation rates, and financing terms. My preference is usually to buy for the reason that pricing seems more transparent. It is easier to talk about loan repayment rates with a car salesperson than how leases are priced out – you’re at an information disadvantage, and therefore in a position to be make a poor financial decision. Plus, I tend to buy used cars, which usually don’t have leasing options available.
Lastly, I wouldn’t expect most people to go into so much detail on their own when figuring whether to buy or lease a car. That’s what I’m here for! If you would like to discuss how to best make your next large purchase, click here to schedule a call with us!