Articles for Financial Advisors

Leasing vs. Buying a Car


Leasing vs. Buying a Car

In 2013, 26% of all cars sold were leased (16% in 2003). There are 5 advantages to leasing a car: [1] you walk away from the car at the end of a closed-end lease—residual value is unimportant, [2] monthly payments are lower, [3] interest rate charges are usually lower, [4] you have the option to purchase the car for its projected residual value at the end of the lease, and [5] most leases come with warranties that cover the cost of most repairs.

According to Experian Automotive, a unit of credit bureau Experian, the typical average monthly payment for a Toyota Camry is $312 (35-month lease payment) vs. $414 (61-month purchase loan). In February 2014, the average rate for a car lease was 2.2% a year; the average rate on a car loan was 4.6%.

There are disadvantages to a car lease: [1] you never build equity unless you purchase at the end of the lease, [2] advertised lease rates do not factor in the additional monthly amount for amortized sales tax and registration—a $350 a month advertised lease will likely end up being at least $410 a month, [3] if your mileage at the end of the lease is > what was originally agreed to (i.e., 6,000 miles a year), you will likely end up paying 25-65 cents per “extra” mile, [4] unless you are a smart shopper, you could end up paying more than necessary in interest charges and additional protection (e.g.,$1,700 for a 3-year protection plan for tires and rims), and [5] the required money upfront means “monthly outlay” is actually higher (e.g., $3,500 due at signing means a lease payment is almost $100 more per month for a 36-month lease). Still, a lease is likely the better alternative (see table) because of its flexibility.

Suppose you decide to buy the car when the lease is about to expire. A small additional benefit provided by the lease is the interest rate you paid during the lease period (call it 36-42 months) was probably lower than the interest rate you would have paid if you had taken out a loan to originally buy the car. This means you saved money during the lease period. If you then decide to finance the car: [1] the interest rate may (or may not) be < what you were going to be charged if you originally bought the car; and [2] you may be able to negotiate a price lower than the residual value, thereby perhaps paying less than what an original buyer would have paid.

In a way, you are given more certainty with a lease since residual value is stated and guaranteed in the lease agreement. Three-to-four years later when the lease is expiring, you know that if you want to purchase the car, you will pay no more than the residual value but may end up paying less.

Why Leasing is Better Than Owning a Car



Monthly payments

Lower with a lease

Interest rate being charged

Lower with a lease

Residual value (at end of lease)

Option to buy the car at or below residual

Residual value determined in advance

Before lease is signed, residual is disclosed

When to consider buying at end of lease

Very low mileage or high market value

Tax write off (business use only)

Almost always greater with a lease

If you end up disliking the car

Walk away when lease ends

Most or all maintenance and repairs

Usually included in the lease

Manufacturer’s loyalty program

Buy or lease another car and save a fee

Purchase incentive toward end of lease

If you buy, first 1-3 payments may be free

Shorter holding period

Term of a lease is usually less

Psychological benefit

Keep the car or replace it after the lease

Comparing a lease to a car loan

Factor in upfront costs, sales tax, etc.


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