Case Study – Buy vs. Lease Your Next New Car
Previously, we laid the groundwork in answering the question, “Should we buy or lease our next new car?”
As promised, let’s now analyze the pros and cons of buying vs. leasing a new $30,000 car.
For the sake of our discussion today, there are two important points to make:
- All money that you spend to purchase and maintain a car is an expense. So, for example, all of the following can fall into the “car expense” category:
- buying the car for cash,
- making a down payment,
- making loan payments,
- making lease payments,
- sales and annual excise taxes, and
- repairs and maintenance
- For the sake of our discussion today, I’m going to assume that you’re going to purchase a new car as opposed to a used, or what today is called a “pre-owned”, car.
A great argument can be made to purchase low mileage used cars. There’s no doubt about it. A few years back, our family purchased a Toyota Land Cruiser outright at the end of our lease, and then recently bought another pre-owned one because we love the car and the newer model was not appealing to us at all. And, the economics worked out perfectly because of our driving habits.
However, for the sake of our comparison today, let’s stick with purchasing a new car.
As I mentioned last week, I believe you should have a long term car buying “strategy” which governs how you purchase cars, so let’s begin to analyze the pros and cons of each method of payment.
Before I begin, I don’t want you to overlook the last few words of the last sentence: “method of payment”. Essentially, that’s what we’re talking about here.
You’re still purchasing a car. The question is what “method of payment” works best for you.
If you buy your cars outright, or use car loans, let’s assume that you buy and keep them for approximately 8 years.
Except for extreme situations, purchasing a brand new car every 3 years with cash or using loans is never a good economic decision.
The reason for this is that cars depreciate massively in the first few years, so you don’t walk away with very much. This is especially true if you trade them in to a dealer.
So, assuming you keep your car for 8 years, your cash outlay looks like the following:
- Year One: $30,000 is paid in cash to purchase the car, plus taxes, title, insurance, and registration fees. Maintenance costs are minimal.
- To free up this $30,000, you take the money out of an interest bearing savings account. Or, you withdraw a larger amount from a tax deferred account like an IRA, and pay taxes before you can net out at $30,000 to pay for the car.
- Years Two through Four: your out-of-pocket costs for maintenance are minimal. (oil changes)
- Years Five through Eight: your out-of-pocket costs can be quite extensive as most significant car repairs and maintenance occur around 50,000 miles:
- new tires,
- exhaust system,
- timing belt,
- tune up, etc.
- Year Nine: Begin the process all over again. Hopefully, if your car has good residual value, you can sell it for a decent sum of money to use toward the purchase of the new car.
However, you do have to take the time to sell it, or take the easy way out and trade it in to the dealer. The downside of that, as you know, is that the dealer will not pay you what your car is worth on the retail market.
- Year One: You begin the process by purchasing a car using a lease. As you would if paying cash for the car, you still pay up-front for any taxes, title, insurance, and registration fees. (It makes no sense to pay a down payment toward the principal on a lease)
The only other cost when you pick up your car is the first month’s lease payment (approximately $450 per month for a $30,000 car). And, just as if you bought the car outright, maintenance costs are minimal.
- As I mentioned in last week’s Strategy, two different $30,000 cars can have monthly lease costs which are $150 per month apart. The reason for this has to do with the residual value of the car (what the leasing company believes they can sell your car for in 3 or 4 years).
Some cars, like Honda (Acura) and Toyota (Lexus) for example, hold their value very well, so leasing them is much cheaper than leasing a Ford.
- Years Two and Three (or Four if a Four Year Lease): your out-of-pocket costs are:
- your $450 per month lease payment, and
- minimal maintenance costs (oil changes)
- Year Four (or Five if you have a Four Year Lease): you begin the process all over again. You turn in your car to the dealer, and begin leasing a new car just as you did three years ago.
What can make leasing an attractive option is that it “month-a-tizes” all of your car expenses: purchase and maintenance. When you buy cars outright for cash, (or use loans), your out-of-pocket expenses are more random.
When you lease, you pay no lump sum down payment. You just make a monthly payment until the end of the lease (3-4 years). At that time, you turn the car in and start all over again. There are three big advantages to this:
- Outside of routine oil changes, you rarely pay for car repairs because cars typically don’t require repair in the first 3 years of ownership. And, you’re not inconvenienced waiting for your car to be serviced.
- You never have to place large sums of money (down payments, etc.) into a depreciating asset. Instead, your money can continue to earn interest or capital gains (potentially).
- You have a predictable monthly “car expense” payment which matches when most individuals receive their income, on a monthly basis.
As you can see, the bottom line is to evaluate your driving habits, and the make and model of the car you wish to purchase first.
If you drive less than 15,000 miles per year (especially if less than 12,000 per year), and you plan to purchase a car with a high residual value, you really should do the math and considering leasing.
However, if you only drive 4,000 miles or so per year (as some of our Relaxing Retirement members do), then it makes more sense to buy outright and keep your car for many years.
Either way, make your decision after carefully weighing the alternatives. Don’t allow yourself to be manipulated by a car salesman or the “manager” at the dealership.
Have a very definite car buying strategy in mind and make your decision on your timetable, not theirs.
Happy car buying!!