The responsible adults always tell you to buy, but a shiny new Tesla seems so nice. You can’t afford to buy that Tesla outright so what should you do? In this article, we’ll dive into the differences, including the pros and cons, of buying versus leasing your next car.
What is the difference?
Leasing is essentially renting a car for a designated period and giving it back (typically after 2, 3 or 4 years). Here are some of the distinguishing characteristics of leasing:
- Some leases don't require you to pay on-going car maintenance
- There are caps on the number of miles you can drive each year, which is negotiated up front so you’ll need to know how much you expect to drive over the given lease period
- If you drive more than your leased miles you will pay extra for each extra mile driven and that cost can add up
- Leasing usually requires less of a down-payment than if you buy
- The cheaper entry may encourage you to lease something fancier and more expensive than you need (or than you could buy).
- If a leased car is totaled, your insurance company will just cover what it is currently worth (after depreciation), not what you owe. This could leave a gap so look into getting gap-insurance. For example, if your car is worth $5000 and you incur $6000 in damages your insurance will pay you $4500 and you will owe the additional $1500. (note, there is a $500 deductible)
- When your lease term is up you give the car back and don’t have to hassle with selling a used vehicle.
- If there is any damage to the car other than normal wear and tear you will be fined for that when you return the car.
Buying a car isn’t without risks. Here are some of the characteristics around buying:
- Typically you are required to pay a larger down-payment if you finance.
- If you finance your purchase, as soon as you drive a new car off the lot it starts to depreciate and you will probably owe more than it’s worth for the next 4 years, (after which you build equity in the car). Gap-insurance is useful in those first few years.
- Once paid off the finance payment ceases, unlike in the leasing scenario.
- If you aren’t the best with keeping the car clean and regularly maintaining it you are free to do so with no formal penalty other than a potential maintenance bill as the car ages.
- As your car ages your insurance cost will go down.
Which one’s cheaper?
To test this, we went to Kelley Blue Book to look up prices of new and used (3, 6,and 9 year old) Toyota Camry and BMW 3-series sedans (basic models with no extra options, in the SF zip code 94103). We also found maintenance estimates. We then compared those prices to Toyota and BMW 3-year lease deals from the manufacturer (and assumed maintenance was included). We assumed that if you lease for 9 years you get 3, 3-year back-to-back leases at the same rate. We assumed gas, insurance, and state fees were similar in both cases, and left those costs off.
We threw all the numbers into a chart to see if buying versus leasing is cheaper over a 3, 6, or 9 year time horizon for both cars. What did we find? In most cases, owning is cheaper than leasing!
Toyotas have lower maintenance costs therefore buying a new Camry and holding it for 3 years is cheaper than leasing by 12% (again, we assumed maintenance is free when leasing). The longer you hold that car (6 or 9 years) your savings increases by owning versus leasing every 3 years for a total of 9 years.
The BMW on the other hand, has higher maintenance costs. If you are just looking to buy a new BMW every 3 years and sell it, you might as well lease (it’ll be cheaper). But if you hold it longer (6-9 years), it becomes cheaper than leasing.
What is right for me?
In many cases, buying will make the most sense. Buying a car and keeping it after you’ve paid it off is cost-effective. Remember, in most places you’re going to keep needing to buy a new vehicle every 8-10 years (and if you’re a family needing 2 vehicles, every 4-5 years). We need to make this process is as efficient and cost-effective as possible.
The folks that are most fit for a lease are those who can’t seem to enjoy their car for more than 3 years. We all know someone who just wants a new car every few years. If this is you, it may not make sense to continue to buy a new car every 3 years (as in our BMW example above). Even if you don’t fit that category, there is an argument to be made that leasing allows you to continue to improve the technology in the car. If you purchased a car before bluetooth was standard it could take 8 years before you get rid of the earpiece.
If I buy, do I finance or pay-in-full?
In general we like the discipline that comes with paying for a vehicle in full. You don’t run the risk of living in excess of your means if you literally only buy what you can afford. I know this sounds crazy to some folks, only buy what you can afford? What an idea! As financial planners, however, we will always want you to live within your means.
Our first recommendation will be to try to pay in full. You don’t have to deal with credit, interest rates, or overextending your purchase. If you can’t pay in full, or are interested in low-cost financing, this is also not a bad idea. If you can find 0% interest for the whole 5-year financing term, that would be fantastic. If the interest rate is <3% a year that is also pretty darn good. Once the interest rate gets to 4% or 5% we start to get a little nervous. Perhaps you should try to put a little bit more down, save more, or get a cheaper vehicle. Once we have interest rates greater than 5% for auto financing, we seriously want to reconsider. Are there no other options? Let’s try really hard to pay <5% or even 3% on our auto financing.
Dealerships are such a headache - is there an easier way?
Unfortunately in the US, auto dealers have a monopoly on new car sales. Tesla is trying to cut out dealers, and some states side with Tesla and others with dealers. So unless you are getting a Tesla, you’ll probably have to get a new car from a dealership. You have lots of options if you want to buy a used car, but for the sake of this article, we are just comparing buying a new car with leasing a new car.
Here are a few tips when you head to the dealership:
- Check out more than one dealership and research purchase prices ahead of time on Kelley Blue Book.
- Email a few dealers before going in-person to get quotes. You can then compare them and get the dealerships competing/lowering their prices over email (saving you time in-store).
- Think about getting pre-approved from your current bank for an auto loan, so you know both how much you are pre-approved for and at what rate. This will force the auto dealership to match or beat your bank’s interest rate.
- Don’t be pressured to purchase unnecessary add-ons, even if it takes 2 hours of arguing with the salesperson to get the superfluous additions removed (as was my painful experience).
- Give your car insurance company a call ahead of time so you know what you’ll have to pay.
- Look for deals (clearing out last year's new inventory), and be prepared to walk away if a dealership won’t give you what you want.
Anything else I should think about?
Leasing carries the real risk that you will get a car that is unnecessarily expensive. We are trying to ‘drive’ a general culture of savings - taking a realistic look at unnecessary spending is a critical part of that calculus. Do you really need a new car every 3 years? Do you really need a luxury car? Are you willing to put your future financial health at risk for a fancier car now? These are honest questions that deserve honest answers.
If you have any questions or concerns, feel free to reach out to your Origin Planner and they can help guide you through this process.