Should I Buy or Lease a Car?

Roxanne Alexander

Roxanne Alexander, CAIA, CFP®, AIF®, ADPA® Senior Financial Advisor

Usually one of the next major purchase decisions (and expenses) after a home is a car. Whether to lease or buy can depend on your circumstances and preferences. I did a rough calculation a few years ago while having a discussion with a co-worker — assuming you bought or leased the exact same car, you would have roughly spent around the same amount after the first three years, assuming there is an opportunity cost to buying a car for cash outright. Depreciation decreases the value the longer you keep the car, so one way to save on a car is to buy a two-to three-year-old car that has taken the initial depreciation hit, keep it for seven to ten years, and hope the repairs are not expensive.

When buying a car there are several things to consider. Do you want to pay cash or finance? Depending on interest rates, it may make sense to pay cash if you have sufficient cash available. If you have $50K sitting in cash earning 1% but your loan would be at 6%, it may make sense to pay cash. If the $50K is all you have in emergency savings, you may not want to tie that up in a depreciating asset and prefer to go the finance route, especially if you are still working. Another consideration would be the probability of you replacing that $50K with new savings once it has been used to buy the car. Some people psychologically have a harder time paying themselves back than paying the bank. Interest rates for new cars are usually cheaper than for used cars and often the dealer may offer very low-interest financing. If your $50K is invested in the equity market and you expect a 7% return or more (that can go either way), you may prefer to finance and leave your money to grow. Another important aspect for retired clients is if your money is all in an IRA or other retirement account — taking out a $50K lump sum to buy a car may actually be a $70K withdrawal once you factor in taxes.

If you are buying a car you would want to check into what is covered under warranty and for how long. Anything not covered would be your responsibility and an extra expense. Most warranties on new cars are not worth the paper they are printed on and often the dealer will try and talk you into purchasing this at the closing. Most car dealers have some negotiating room which can be up to a couple thousand dollars, especially if a new model is coming out, so do your research before negotiating. Another point to consider is if you have an accident with a car you own, when you try to resell it you are going to get a lower value for it. Some insurance policies offer coverage for this. Before choosing a car it may make sense to check out resale values for that type of car so when you are ready to sell you will get a reasonable price. In order to get a good sense of how much a car costs, TrueCar.com is a great tool. It aggregates all the new or used cars in the area based upon factors you determine (make, year, model, etc.).

If you tend to keep cars for a long time, purchasing may be the way to go, but if you like new cars and like to change your car often, you might want to look into leasing. Also, you will likely be able to get more car for your money with a lease. There is usually an upfront cost to leasing which is an amount due at signing (tax, tag, title, down payment, delivery costs, etc.). This lump sum usually reduces your monthly payments and may be required depending on your credit. Some dealers offer $0 down but all this does is increase your monthly payments — it is all a numbers game, so if you take somewhere you give it back somewhere else.

There are also several perks such as maintenance, tire protection, and dent and scratch coverage that you can buy which will increase your lease payment. Some brands will offer free maintenance throughout the duration of the lease, which can be quite convenient. Most standard lease offers refer to 10K mileage limits. If you drive more than 10,000 miles, this will also increase your payments on the front end or on the back end when you return the car you will be required to pay for the extra miles. It is usually cheaper to pay for the miles before you return the car and in some cases there is a time frame to do this. Extra mileage can range from around $0.15 to $0.30 per mile and can add up fairly quickly. At $0.30 a mile 3,000 extra miles will cost you $900. If you drive more than 15,000 miles annually, purchasing a car may also be cheaper for you as leases have mileage limits — if you are driving 25,000 miles a year this can get restrictive and expensive. Keep in mind even on a purchased car, the increased mileage will fetch you a lower sales price when you are ready to sell anyway.

Other considerations may include whether you have teenagers who may be driving soon. In this case it may be an option to buy a car and pass it on to one of the kids when it is a little older rather than buying another new car or taking out a lease. Leases also require full insurance coverage to protect you and the leasing company, so if you want to pay less insurance purchasing may be a better alternative. Additionally, leased cars usually have GAP insurance built in — this pays the difference between what you owe and what your car is worth if stolen or totaled in an accident. Loans do not usually have this coverage, so you would need to check with your insurance company to see if this is something they offer.

If you have to terminate your lease early, this is a useful website that I have used several times and found very efficient; however, not all car brands are supported: www.swapalease.com.

Lastly, if you own your own business and can use lease payments or mileage allowance as a tax write off, this may be another factor to consider.

Feel free to contact Roxanne Alexander with any questions by phone 305.448.8882 ext. 236 or email: RAlexander@ek-ff.com.

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