To save money, I focus on large purchases, as even a small percentage savings can add up to large dollars. This is why I started with analyzing how much I could save with a refi. The next largest purchase for most people is a car. One of the most common questions I get asked is, “Should I lease or finance a car?” You could also purchase with cash, but when rates are low, it may still make sense to finance as you get to use somebody else’s money! Vehicle financing doesn’t have the favorable tax treatment like mortgages, but cheap money is still cheap money. Especially if a manufacturer is offering a low rate to drive vehicle sales!
A lease provides many advantages. You can get a brand new car with lower upfront and monthly payments. Lease rates can also be more favorable, as car manufacturers prefer selling leases vs. financing. Not only will you be back in the market in a few years, they can also make another sale on the car you return. Leasing is also good because the car is new and under warranty, so there’s very little risk you’ll have a large out-of-pocket expense, unless it’s in an accident. And after the lease is up, you can return the car without any hassle. In the world of finance, this is called a put option, because you have the option to force, or put on somebody else to buy the car at a set price.
This option can be very valuable. For example, let’s use the case of the VW emissions scandal. When it was first discovered that VW cheated on its emissions tests, the value of diesel VWs dropped precipitously. If you owned one of the vehicles affected, the resale value of your car came crashing down through no fault of your own. However, if you had leased, the manufacturer would be forced to purchase your car at a price that was set before the scandal. Thankfully, VW provided some compensation to offset the decline in resale value, but as a leasee, you pass on the resale risk to the manufacturer.
Depreciation is What Makes Cars so Expensive
If leases are so great, why doesn’t everybody do it??? Well, like anything that makes life easier, it’ll cost you. Even if you get a better rate and higher rebates vs. financing, the problem with leases is you’re still paying the depreciation, during the period when depreciation is highest. The general rule of thumb is you’ll lose 10% just by driving it off the lot. You could lose as much as $3k on a $30k car as soon as you’re handed the keys!
Depreciation varies by manufacturer and model, but most estimates are for 20% depreciation in the first year, and then 10% each in your 2nd and 3rd years. So after 3 years (most leases are for 36 months), your car will only be worth 60% of what you paid for it. After 5 years, it’ll be worth ~45% of what you paid and after 10 years, ~25% of your purchase price. So in the years 6-10, you’ll lose 20% of the initial value, the same amount you lose in the first year alone!
Below is a calculator estimating how much your car will be worth after every year you own it.
Should I Finance a Car Instead of Leasing?
Buying a used car is much cheaper than buying new because somebody else takes the big depreciation hit for you. If you finance a new car or lease it, you still get hit with depreciation. So why is financing better than leasing? It’s because when you lease, you’re back in the market a few years later, and you’ll go through another round of high depreciation. People who finance a car generally keep it for much longer than 3 years and since they keep it longer, they’ll get hit with less depreciation in the latter years.
Don’t Own a Depreciating Asset
I’ve had people tell me you lease because you don’t want to own a depreciating asset! It’s true, you don’t want to own a depreciating asset. It’s obviously better to own an asset that goes up in value than one that goes down. However, most people need a car to get around and they don’t make cars that appreciate. I guess you could buy a Ferrari or a classic Shelby Cobra, but I’m sure even they would depreciate in value too if you used them as daily drivers.
The problem with a lease is you still own the vehicle. It’s just that you have the option to sell it back to the manufacturer after a set period of time. If you total the car, you owe the entire cost of the car, not just the portion you leased. An example of not owning a depreciating asset is if I borrowed a friend’s car. My friend is responsible for the payments, not me. If I totaled it, he’d be responsible for paying off the balance, not me. This site is about saving money, but stiffing your friends is not a good way to do it!
Leasing Saves Money Through Less Maintenance
Another argument I hear a lot is that leasing costs more upfront, but you save in the long run by avoiding costly repairs. This may have made sense in the past, but cars these days are much more reliable. The bumper to bumper warranty is usually four years, but expensive maintenance doesn’t usually happen until you hit 100k miles. The average driver drives around 15k miles/year, which means the expensive maintenance doesn’t happen until year 7. One of the more costly maintenance jobs is changing the timing belt, which could cost around $1k, depending on the car. Again, if you bought a 1-year old car that has a sticker price of $30k, you’d save $6k, more than offsetting higher maintenance costs down the line.
You’re Such a Hypocrite!
It’s true! I bought a used car back in college and I’ve never leased, so how can I tell people to buy used when I don’t do it myself? Well, I like buying new because I like to pick the colors and options that I want. I also keep my cars for a long time (mine is 14 years old now and still going strong!). I also I take pride in knowing that all the accidents are from me, and not some other bad driver. From a strictly financial perspective, however, it doesn’t make sense to buy or lease a new car. If you want to buy a new car, you should, as long as you know how much you’re paying for that new car smell.