The Real Math of Lease vs Buy
New car – financially, is it better to lease or buy?
If asked whether it’s better to buy or lease a new car, many people would give answers such as, “leasing is like renting, you’ll have nothing to show for your money,” or “you throw your money away when you lease.”
To some extent, those answers are correct, but it has less to do with leasing than with having assets (cars) that depreciate in value over time. The longer they are owned and used, the more they depreciate. Cars all suffer value depreciation whether they are purchased or leased.
About depreciation
An average new automobile will lose half — 50% — of its original MSRP value over 3 years. A car priced at $26,000 when new will only be worth about $13,000 after 36 months, assuming that it has an average number of miles on the odometer and that it has only normal wear-and-tear and no significant damage. Higher mileage and/or more wear-and-tear further lowers the value. You can verify this by playing around with used car values on the Kelley Blue Book web site (kbb.com).
When you purchase a car with an auto loan, you pay for the entire original cost of the vehicle, plus finance charges, over the term (months) of the loan. At the end of the loan, say 36 months, you own a vehicle that is worth less than half (if you also consider lost finance charges) of all the money you’ve paid.
When you lease a vehicle, you pay only for its expected depreciation (plus finance charges), not the entire original cost. Since depreciation accounts for 50% (in 3 years) of original value, the monthly cost of leasing is roughly half the cost of buying a vehicle with a loan.
To be fair, if you’re a car buyer who purchases a vehicle and drives it until the wheels fall off, it really doesn’t matter if it’s only worth 50% of what you paid at the 3-year mark. You’re going to wring every bit of use and every dollar of value out of it over many more years of driving.
However, if you like to buy your vehicles new and sell or trade them every 3-4 years, you are essentially leasing. The overall cost, either way, is about the same, although you would have had lower monthly cost (payments) with the lease.
When you buy with a car loan, you don’t “own” the vehicle during your loan term (the bank or finance company does) and when you sell or trade at the end of 3 years, you have lost the same 50% of value as someone who has leased. Furthermore, if your vehicle has higher-than-average mileage or high wear-and-tear, you pay for it in additional lost value, just as someone leasing would have to pay lease-end mileage fees and excessive wear charges.
Leasing and buying with a loan are not that much different.
Let’s do the math
Let’s assume a new Honda Accord priced at $26,000. We’ll compare a 3-year loan and a 3-year lease for this car. After 3 years, the car will be worth 50% of original value, or $13,000 — regardless of whether we lease or buy. Our finance rate for both the loan and lease will be 5.0% APR. We’ll assume no down payment for either.
Loan – For our loan, we plug our numbers into an online Auto Loan Calculator and find that, for a 3-year term, our monthly payments will be $779.24. Total finance costs are $2052.76, making the total cost (ignoring miscellaneous and official fees) of our purchase $28,052.
If we sell or trade our purchased vehicle in 3 years (assuming normal mileage and wear), we’ll recover $13,000, losing $15,052 to depreciation and finance charges. Our total cost is therefore $15,052.
Lease – For our lease, we’ll use the same numbers except we’ll add Honda’s standard $595 acquisition fee to our cost. We’ll also add a typical $350 disposition fee that is charged when the vehicle is returned at lease-end. We’ll again assume normal mileage and wear, therefore no other lease-end charges.
Plugging our numbers into our Lease Calculator, we find that our monthly payments will be $460.13. Total lease cost will be the sum of payments over 36 months, $15,565, plus $350 disposition fee, for a total cost of $16,915. Total finance cost is $2993.
When calculating a lease, we use “money factor” instead of interest rate, but the conversion is easy: divide interest rate by 2400. Therefore our 5.0% APR interest rate becomes .0021 lease money factor. Residual value is simply the expected lease-end value of the vehicle, $13,000, after depreciation.
Sales tax – In most states, sales tax is paid on both purchased vehicles and leased vehicles, although the way in which it is applied differs (in most states) , which can be an advantage for leasing. Let’s assume the local tax rate is 6.0%. For a $26,000 vehicle the tax for a purchase is $26,000 x .06 = $1560. For a lease, the tax is applied to each monthly payment ($460.13 in our example). So, $460.13 x .06 x 36 months = $993.
Recap
Loan | Lease | Comments | |
Payment | $779.24 | $460.13 | Lease payments are 41% less than loan payments |
Finance Cost | $2053 | $2993 | Lease finance cost is $940 higher than loan finance cost |
Sales Tax | $1560 | $993 | Sales tax is $567 less for lease |
Total Cost | $16,612 | $17,908 | Total lease cost is $1296 more than total loan cost, assuming purchaser sells/trades car after 3 years |
What could change the numbers?
Manufacturer incentives such as rebates, low-interest loans, and special lease deals can have a large effect on “lease vs buy” comparisons.
For example, rebates can lower the cost of a purchase and 0% APR loans mean zero finance costs, although customers are almost never allowed to choose both.
However, special leases offer the greatest possibility for best deals because manufacturers can not only discount price and offer low finance rates, but can also create high lease-end residual values — all at the same time. It’s the combination of all these factors that give the edge to promotional leases. A manufacturer’s special lease deal can easily win out over a rebate or 0% loan deal.
It may not be possible to qualify for a manufacturer-sponsored low-interest loan or special lease unless you have a good credit score. What’s your FICO score? Find out now when you check your credit report for $1 at Experian.com! Don’t go car shopping without knowing where you stand with your credit.