Should you buy your car or lease it? This is a
question that we hear often and as usual, the answer is that “it
depends.” It is also an answer that I could compose an entire book
First of all, let me start with the most practical advice from a
personal finance perspective which is that you should do either if they
involve a new car. A car loses 15% to 20% of its value the first year.
This is a big hit that is better left for someone else to take. With
that being said, most of you who know me can know call me a hypocrite
because I have not purchased a used car since I was in college. There
is nothing like pulling away from the dealership in a shiny new vehicle
with the seductive new car smell.
Now that we have determined that you are getting a new car against
my advice, we can get down to the details of whether you should lease
it or buy it. First, you must understand that the basic premise of
leasing is that it is simply another way to buy the vehicle. You are
not renting the vehicle from the manufacturer. Car dealers love leasing
cars because it is very easy for them to tinker with the numbers and
make a much higher profit. It is important that you, as the buyer,
understand how leases are calculated.
To better understand how leasing works, think of a conventional loan.
At the beginning of the loan, you owe the purchase price (less any down
payment, etc) of the vehicle. At the end of the loan, you owe nothing.
A lease is very similar, except at the end of the term, you owe the
residual value stated in the lease. At the end of the lease, you must
give them this value – either by turning the car in or by paying them
the residual value. When you think of the lease like this, it is
similar a purchase with a balloon payment at the end of the term.
Almost all automobile leases today are closed end leases, and that is
what I will discuss here. If you are considering a lease, be sure to
confirm that it is a closed end lease before signing. In a closed-end
lease, the leasing company bares the risk of the depreciated value
because the residual value is set at the onset of the lease. If at the
end of the lease, the vehicle is worth more than the preset value, you
can still buy the vehicle for the preset residual value. If the vehicle
is worth less than the preset value, you have the option to turn the
car in and the leasing company takes the hit for the difference.
Advantages to Leasing:
Monthly Cash Flow. Leasing provides better monthly cash flow. If
you are an individual that likes the benefits of leveraging yourself
and your investments, this can be advantageous. If you can invest the
monthly savings into an investment at 15%, 20%, or even more, why would
you tie up your funds when you are only saving 7% in interest? That is
also true when buying a vehicle and paying cash. Why would someone tie
up $35,000 in cash when they can earn much greater returns on that
cash? With this being said, most people are not investing in things
that consistently give them these returns. In addition, ninety percent
of the people that plan to use this leverage at the onset of the lease
never do. They end up spending the money on other expenses that have no
long-term value. If you plan to use leverage, be sure to set it up
immediately and stick to your plan. I do not recommend this for most
people because over ninety percent people do not have the will to stick
to the investment plan. If this is the case, they are better buying and
saving the additional interest that they will have to pay.
Gap insurance. Most leases provide for gap insurance at no
additional cost. Simply speaking, gap insurance covers the difference
between what you owe on a vehicle and what it is worth. With little or
no down payment, this gap will usually exist whether you finance a
vehicle traditionally or lease it – although the gap is usually larger
when leasing since a smaller portion of your monthly payment goes
toward reducing your financed balance. If you are in an accident and
total your leased vehicle (assuming your lease provides gap insurance),
the insurance would cover your equity difference. If you financed the
vehicle, you would be required to pay the difference yourself. While
this sounds like a big advantage for leasing, take it with a grain of
salt. How often does one actually total their car and use the gap
insurance? My guess is not that often. While it is usually an advantage
toward leasing, I wouldn’t base my decision based on the gap insurance.
Although it is not common, there are a few banks that offer gap
insurance with traditional loans.
Taxes. If you are using the vehicle in your business, you can deduct a
portion of the expenses related to it. The Internal Revenue Code limits
that amounts you can deduct then you buy a vehicle through Luxury
Automobile depreciation limits. These limits vary depending on how long
the car has been in service, but range between $2,850 and $5,200 for
the first three years that the car is in service. With a lease, you can
deduct the full amount of your lease payment (based on your percentage
of business use). This deduction can be significantly larger than you
can deduct through a purchase. I recommend consulting your tax advisor
to determine if you qualify and what your deductions may be.
Advantages to Buying
Long-term Cash. Long-term cash outlay is almost always less with a
purchase. This is true whether you plan to purchase a new car every 3
years or every 10 years. If you plan to keep the vehicle an extended
period of time, the cash outlay can be considerably less by buying it.
If you are the type of person that wants to have a car that is
completely paid for with no payment, traditional financing is the
option for you. It is the fastest route to eliminating a monthly
Miles. If you buy the car, you can put as many miles on it that you
like. When you lease a vehicle, you are limited in the number of miles
that you put on the vehicle. Approximately 10 percent of all leasers
exceed their mileage allowance and it is not uncommon for leasers to
exceed this allowance by 5,000 miles per year. At 15 cents per mile,
this can result in additional payments at the end of the lease well in
excess of $2,000. There are many variables that can change related to
your annual mileage. Be sure to examine them before deciding to lease a
Taxes. If you are using the vehicle in your business, you can
deduct a portion of the expenses related to it. Section 179 of the
Internal Revenue Code allows qualifying businesses to deduct the full
cost of equipment purchases in the current year (up to $128,000 in 2008
including up to $25,000 for qualifying automobiles). The catch related
to cars is that they are typically not considered equipment. For them
to qualify, they must be at least 6,000 lbs of gross vehicle weight (as
determined by the manufacturer). If you are searching for an SUV or
truck that you will be using in your business, be sure to find out the
weight and check with your tax advisor on whether or not your business
Buy or Lease?
As you can see, there are advantages and disadvantages to both
options. In addition, many of the advantages or disadvantages do not
apply to all people. As a general rule of thumb, I believe most people
are better off buying the vehicle because most people do not have the
financial discipline to make good use of the monthly cash flow savings.
As with any major decision, I would suggest contacting your tax and
financial advisor to help determine which is right for your situation.
About The Author
Chad Bordeaux is a Certified Public
Accountant and Certified Fraud Examiner residing just outside or
Charlotte, NC in Lake Wylie, SC. He has a wide range of experience from
former positions including corporate and SEC accounting, financial
reporting, tax compliance, and Sarbanes-Oxley compliance. http://www.yourcpapartners.com