Buying vs. Leasing Cars

As you save toward FIRE, maximizing the value of your spending is critical.  With only so many dollars to go around, the better value you get when purchasing your day to day necessities, the more you’ll have left over to contribute to your retirement investments.  In this post, I’ll talk about the pros and cons of leasing vs. purchasing a vehicle, one of the age-old conundrums of the prudent investor since perhaps the invention of the cursed wheel, or thereabouts.

Unless you live in New York, and more specifically, in Manhattan, the car has become among the most ubiquitous of daily necessities.  In most places in the US, you can’t even make it to the grocery store without a car, let alone to work or anywhere else.  Sure, there’s public transit, and in some places it’s better than others, but by and large, unless you’re willing to sacrifice the time it takes to use public transit, you’re stuck driving your own vehicle.  Perhaps someday in the not too distant future, humanity will figure out how we can all live amongst on-demand autonomous vehicles, but until then, the great lot of us are forced to plunk down hard-earned money to acquire the conveyance that moves us about town.

So, if you’re in the situation where you have little choice but to have your own car, does it make more sense to purchase the car or to lease it?  There’s quite a bit out there on the internet about this topic, and yet I’ve had a difficult time finding a conclusive suggestion.  And I probably won’t give one either, mostly because I think the answer depends on what type of car you want to drive and your tolerance for taking on the risk of long-term maintenance.

Let me point out here, before getting into the whole buy vs. lease debate, that the type of car you acquire falls into the category of FIRE-related tradeoffs.  There are plenty of economical vehicles, mid-range vehicles, and luxury vehicles, and the range in price between them can amount to several hundred dollars per month.  The difference is not just in the price you pay to buy or lease the car, but also the insurance and registration fees, both of which are more expensive for a pricier car.  If you’re looking to tighten your spending on day to day expenses, having a more economical car is certainly one area you can save a great deal of money.

Getting to the topic at hand, let me frame some of the main points of the debate:  

Buying

Proponents of buying will be quick to assert that when you purchase a car, you acquire an asset in which you have an interest in the value you accumulate.  That is, after making payments on a purchased car, there is value in the car that belongs to you.  You can sell the car and the portion you own is cash in your pocket.  With a leased vehicle, you can’t do that. 

Moreover, when you purchase a car, there will come a time when you no longer have to make any payments on it.  After the financing period is over, and you’ve made all your payments, the car is yours and now you only have to pay for gas, car washes, and maintenance.  Meanwhile, if you lease cars, you’re always making payments. 

Finally, the big one.  Purchasers will tell you that a leased car runs the risk that you’ll go over the maximum mileage, resulting in a big payment when you return the car due to the excess mileage costs.  They’ll say that this doesn’t happen when you buy the car.  

Leasing 

Proponents of leasing will remind you that leasing a car requires a lower down payment and lower monthly payments.  They’ll also remind you that when you lease a car, typically the lease term is often not much (if at all) longer than the warranty term, meaning that you always have a car that is within the dealer’s warranty. 

Likewise, when you lease cars, you’re able to refresh your car every few years, meaning that you’ll have a newer car that is less prone to problems associated with wear and tear.  Finally, fans of leasing make the valid point that even though you don’t acquire an interest in the vehicle when you lease it, cars are (rapidly) depreciating assets, meaning that even after making payments, the cash value a purchaser can extract from the car shrinks over time and eventually reaches $0.

Both seem like valid arguments, so let’s break them down.

Buying Considerations

First question, and this is relevant to FIRE savers who may have some accumulated holdings: should you just buy a car outright with cash and not have to make any financing payments or incur any interest charges?  Answer: most likely not.  And the reason is the same as my point on emergency funds and debt – you can probably do more with that money by leaving it in the market than laying it out to avoid interest charges.  

For the most part, car loans are fairly inexpensive.  Often, at least on domestic or more economical cars, there are no interest charges at all (but there are some fees, etc. when you finance the car).  Luxury cars tend to have interest on their financing loans, but they’re still relatively low, often below the rates you might find for a home mortgage.  This is because the car manufacturers have their own finance companies that they use to induce buyers to purchase their vehicles.  Not a bad idea. 

Remember too that you’re not beholden to those finance companies – you can get a car loan from a bank as well, which you might want to look into before using the manufacturer’s finance, especially if you have good credit.  You might be able to obtain an even lower rate than what the dealer is offering.

Because the interest rates on cars are relatively low, you’re likely better served by not touching your accumulated savings and letting it work for you in the market.  Even if that means having to make monthly payments.

That out of the way, let’s discuss the mechanics of purchasing a car.  When you buy, you’ll make a down payment the day you sign and thereafter you’ll have a monthly finance payment to pay off the car loan.  Dealers (and banks) typically offer several options for the term of the payment: 36 months, 48, 60, 72, etc.  The shorter the term, the higher the payment, and the longer the term the lower the payment.  Of course, the longer the term, the more overall interest you’ll pay, but again, this might not be bad if the money you’d otherwise spend to pay off the car earns more for you in the market than saves you in interest charges.

Once you’ve made all the payments, the car is yours, clean and clear.  You don’t owe any more money to the dealer and you get to use the car without further payments as long as you like.  Plus, when you do decide to buy a new one, you’ll have a trade-in that you can use to reduce the purchase price of the next car you buy.

Great?!  Maybe. 

Notice the loan terms.  With 36 or 48 months on the shorter side of loan terms, compare that to the average manufacturer’s warranty of 3 years (or some amount of miles, typically 30,000 – 36,000 or so).  (Don’t confuse the manufacturer’s warranty with things like the powertrain warranty, etc. – which, although they have longer durations, are not as comprehensive).  What this means is that, on average, before you even pay off the car, it’s out of warranty.  And by the time you do pay off the car, it’s well out of warranty.

Have you ever had to pay a mechanic?  If you haven’t, consider yourself lucky.  Because it is EXPENSIVE.  And owing to the fact that cars are moving toward becoming computers on wheels, new cars are very complex, meaning it takes longer and more expensive mechanics to fix them, all of which can cost you a bundle. 

Anecdotally, my own 2019 model year (leased) car overheated at 3,000 miles (which probably shouldn’t happen…).  I took it to the dealer and they had it for just about 2 weeks, ran all sorts of diagnostic tests, and yet they never figured out what went wrong.  They just replaced something in the engine and sent me on my merry way.  I can’t imagine what that would have cost if not covered by the warranty.

Also remember that once you’re out of warranty, you’ll be on your own finding a replacement car while yours is being fixed (for a maintenance issue, not an accident where a rental might be covered by insurance).  In my example, imagine if I had to pay say, $50/day for a replacement car?  After two weeks, that’d be $700.  Replacement costs and mechanic’s bills are all out of pocket to you, and, let’s face it, even if you’re not making car payments anymore, these costs can eat into any money you’ve saved.  

And what about the miles you put on the car?  While it’s true that you don’t have a mileage cap on a purchased vehicle, meaning that you won’t pay for going over an allotment as you would with a lease, don’t forget that every mile you put on that car reduces its residual value.  So yes, you won’t have an out of pocket cost when you trade-in or sell the car, but your trade-in value or sales price will be reduced accordingly based on the amount of miles you’ve put on the car.  A high-mileage vehicle sells for a great deal less than one with low miles, meaning that there’s still a very real cost associated with how many miles you put on your car.

Leasing Considerations

When you lease a car, you’ll typically make a down payment, and just like when you purchase, a monthly payment.  The monthly payments will be for a term of months, generally in the range of 24 to 36 (and sometimes 39 months), and when you’re done with the term, you bring the car back, they take it from you, and then you have to get a new car.  If you lease cars, there will never come a time when you’re not making monthly payments and every few years you’ll have to make a new down payment.

Another condition associated with leasing is the mileage allotment discussed above.  A lease will come with a set number of miles you can put on the car (10,000 per year is the standard), and any overage is charged per mile, typically at 25 cents per mile.  If you so desire, dealers will sell you additional miles at the time of the lease.  If you think you’ll go over the 10,000 being offered, they’ll up the allotment, and typically the price increase per mile if you bake it into the lease is less than the charge if you go over.  Just make sure you don’t needlessly pay for a higher mileage lease than you need – you’d essentially be paying extra for no reason.

Additionally, when you return a leased car, the dealer will charge you for “excess” wear and tear.  What does this mean?  It’s tough to say, but generally for things like large dings, broken glass, broken parts, bald tires, things like that.

Another anecdote: in my experience, when the expiration of your lease is approaching, dealers will make you offers to induce you to lease a new vehicle with them, including to waive any excess mileage and charges for wear and tear.  If you’re looking to lease the same type of car, this means there are options to get out of, or reduce, those additional charges.  Be warned, however, that there’s no guarantee they’ll do this, and they certainly won’t if you choose to lease or buy from a different dealer.  

So what’s the upside of a lease?  Look at those monthly terms.  If you lease cars for 36 months, you’ll likely be within the manufacturer’s warranty at all times (assuming you don’t go over the mileage limit on the warranty either), meaning that you never incur a cost when something goes wrong with the car.  Of course, if you break something, that’s on you, but standard car issues are all for the most part covered.

Moreover, lease prices are often less expensive than purchasing.  Lower down payment, lower monthly payment, etc.  So, over three years, you’ll pay less to lease the car than purchase it.  Of course, the down side of this is that you never accrue any ownership in the value of the car, meaning you can’t sell it and capture the residual value.

Another aspect that you may not think of is what happens when you miss a payment.  In most states, when you lease a car, it’s not considered your property, whereas a purchased car, even one you finance, is still considered your property.  If you miss a payment on a leased car, it can be repossessed immediately, meaning they can show up and tow it away from wherever you parked it.  With a financed car (in most places), the finance company has to foreclose on the loan before repossessing it.  This is probably not as important, but something to think about nonetheless.

Example

An example might do some justice here.  These numbers are very rough, because, as anyone who’s ever been to a car dealership will tell you, there’s much negotiating to be had, for better or worse.

Let’s assume a car with a $35,000 purchase price.  If you lease that car, you’ll probably put down somewhere in the neighborhood of $2,500 for a down payment, and you’ll have monthly payments of about $350 (including tax) for 36 months.  Over the term of the lease, including the down payment, you’d pay about $15,100.  

(*Side note: when negotiating a lease, sometimes the dealer will lower the monthly payments by increasing the down payment.  Make sure you add up the total payments, because often when they do this, the total payment amount goes up – don’t fall for these tactics.)

If you purchase, you’ll probably pay a down payment of about $5,000.  Assuming a 60 month term and a 2% interest rate, you’d pay about $525 per month.  This means that in the first 36 months, you’ll have paid $23,900.  Over the entire term of the loan, you’ll pay a total of $36,500.

At 36 months, with the lease you’re several thousand ahead ($15,100 vs. $23,900).  But, you need a new car.  So you go back to the dealership, pay another $2,500 down payment and take out a new lease on a new car with monthly payments of $375 (some accounting for inflation, etc.).  At 60 months, with the purchased car you’re out $36,500, while with the leased cars, you’ve paid $26,600 ($15,100 + ($2,500 + 24x$375)).  So you’re still ahead with the leased car, plus you have a new, in-warranty vehicle.

Take this out to year 9.  With the purchased car, you’ve still spent $36,500 to acquire the vehicle.  Assuming a third lease renewal after 6 years with another $2,500 down payment and a new lease term of $400 per month, at year nine you’ll have spent a total of $48,000 ($15,100 + $16,000 + $16,900) on leasing cars.  Leasing cars has now cost $11,500 more over nine years and at year nine you’re on your way to the dealership to get another new car.

But, with the leased car, you’ve probably never paid any money on maintenance (other than oil changes) or for anything broken.  Instead, you’ve had new cars covered by the warranty.  Does that make up for the $11,500?  It could, depending on the type of car.  Nowadays the more economical cars tend to have relatively lower costs to fix while the luxury cars are more expensive.  So the difference might come down to your preferred vehicle type.  

These are of course very rough numbers, don’t account for miles, and aren’t specific to any type of car.  But the point is that there are fairly narrow margins.  The risk of a lease might be lower over the same time frame, particularly because a new car is less likely to have problems, and when it does, they’ll be covered if under the warranty.  One major out of warranty problem with an owned car and your margins are blown. 

Also think of this: when you’re leasing the car and spending less per month in those first few years, that can be more money you have to invest at that time, which can benefit from a longer time frame in the market.  With the owned car, after 5 years in this example, you’ll have a much larger amount to put in, but it’ll spend relatively less time in the market.  It’s difficult to predict with much certainty how this works out, but you see the point of the trade-off.

Conclusion

There are so many considerations that go into whether you make out better buying or leasing a car.  In the short term, you’ll likely do better leasing, but over time may end up spending more.  However, there’s definitely more risk to purchasing over the long term due to the potential for maintenance costs that eat into the difference between buying and leasing.  

Generally speaking, I’m a fan of leasing.  It’s less headache and you don’t have to consider the long-term risk of owning a depreciating asset that’s subject to maintenance problems.  I’d rather take the money saved by leasing, invest it, and let it grow for a longer period.  

But, there’s really no right answer.  I’d say that if you’re inclined toward driving cars with a known track record of long-term reliability and that don’t cost a fortune at the mechanic, you’re probably better off buying in the long-term.  If you like “luxury” cars that are subject to maintenance issues and cost a small fortune to fix, you’re probably better off leasing and mitigating the risk of expensive maintenance costs.  There’s also the option of used cars, which nowadays may have even better warranties than new cars, but I’ll leave this for a different post.

Did we solve the debate?  Certainly not.  But hopefully now you have enough information to run the calculations for yourself, consider your preferences, and make an informed decision.  And perhaps advances in technology and improvements in public transportation will moot this debate at some point in the future.