There are some can’t miss ways to start an argument.  Talk politics in a diverse room.  Attend a Michigan home football game wearing an Ohio State jersey.  Suggest that The Rolling Stones were better than the Doors and that Highlander was the best movie ever made.  Or just decidedly state that buying a vehicle is better than leasing.

The animosity that exists on online message boards over the lease vs. buy debate is second-to-none in the financial world and so we knowingly risk alienating friends when delivering the advice that is to follow.  Look, the financial argument for buying a slightly used car, driving it for 17 years and 212,000 miles is easy to make.  This is going to result in lower auto expenses over a lifetime and it does not require any heavy mathematics to come to this conclusion.

That said, we’ve done the enough economic analysis of specific lease vs. buy decisions to fall squarely on the buy/finance side of this debate.   The math, even when you factor in higher taxes, depressed resale values, and opportunity costs of large upfront costs, nearly always favor the purchase.  We are careful to say “nearly always” as there are some unique circumstances when the lease option works out to more advantageous than the purchase.

There’s no easy way to attack this debate as the economics of each lease vs. buy decision are going to be different.  What we’ve chosen to do here is to simply collect the common defenses of leasing and then assess their practical validity.

Leases are a good way to have predictable total cost of ownership

The case can be made that leasing a vehicle eliminates the variability of the trade-in-value that you encounter when selling a purchased vehicle and that this, in turn, makes for a more predictable cost of ownership.  This is not a terribly compelling argument.  Notably, a lease doesn’t provide predictable total cost of ownership if you damage the vehicle, drive over the mileage limits, or incur greater than “normal” wear and tear.  Dents, scratches, or chips can all reduce the residual value for a leased vehicle which often makes the cost of leasing no more predictable than the cost of owning.  Add extra mileage charges to the equation and no one should enter a lease thinking that the cost of ownership is predictable.

You should buy what appreciates and lease what depreciates.

There are rules of thumb that are of no value and then there are rules of thumb that are just plain bad advice.  This falls into the latter category.  In theory, the logic may sound reasonable.  You want to own assets that are going up in value (real estate) so you can benefit from the appreciation and lease assets (automobiles, photocopiers, etc.) that are going down in value so another party is encumbered with the depreciation.  The real world problem with this advice is that the other party in a lease (lessor) knows that the leased asset is going to lose value.  The lessor is resultantly building that expected depreciation or expected loss of value into the price of the lease.  In fact, because the lessor is taking on the risk of greater than expected depreciation, they’re actually building in more depreciation cost than what you should expect if you simply owned the asset.  No one should be fooled into thinking that they’re minimizing depreciation expenses by leasing.  Leasing a vehicle every three years instead of buying a new vehicle every five years just means that you’re incurring the stealth depreciation costs more frequently.

If you only have a small down payment saved up, leasing may be a better option.

This is to say, if you don’t have much money saved for a down payment and you want to buy a more expensive vehicle than you probably should be buying sooner than you should be buying it, leasing is a good option.  Hard to argue with this logic.  Alternatively, you could take the more financially prudent approach and wait until a larger down payment is saved up before purchasing the vehicle.

Leasing means no huge up-front costs or capital outlay.

This argument reminds of an article written on this blog a few years ago about children who were choosing between one marshmallow now, or if they waited 15 minutes, two.  There is admittedly an opportunity cost to purchasing a vehicle in that you have to put more cash down on day 1 that could otherwise be invested to earn a return.  However, any analysis we do in evaluating the purchase vs. lease decision considers this opportunity cost.  Even if we assume a high rate of return (which may not be very reasonable in a low yield world) for the money that is saved by the lower down payment, the economics still almost always favor the purchase. 

Leasing allows you to drive a more expensive vehicle than you could afford if buying.

It was also true that your jobless and irresponsible college buddy could buy a really nice second home with 0% down in the mid-2000’s.  Just because leasing lets you afford a more luxurious car by back-end loading the costs does not mean that this is a wise route to follow.

Leasing is easier on your cash flows as monthly payments are lower.

Again, this is a valid point but that does not mean it is a good point.  In fact, leasing often results in monthly payments that are 30-50% less each month than the repayments on a financed auto loan.  Consider also that buying a home with an interest-only mortgage, letting the balance on your credit cards accumulate each month, or choosing to defer zero income to an employer-provided 401k are all easier on your monthly cash flows than the alternatives.  Just because one option is easier on your cash flows does not mean that option is financially wise.  Yes, leasing a vehicle does require less cash flow each month but this comes with a higher long-term cost.  If the only financial objective in life was to maximize cash flows, you would simply save zero for retirement and plan to work forever.

Leasing means you pay less upfront sales tax

When you lease a car, you only pay the sales tax on the monthly payments (in most states), not the total cost.  This does not mean that the total cost of ownership is lower from leasing – just that you’ll pay a lower sales tax.  If you’re only worried about sales tax and nothing else matters, then you should forget about the economics of buying versus leasing and just move to New Hampshire or Oregon where there is no sales tax.

Leasing has favorable tax treatment if you’re using the vehicle for business purposes.

This is a widely held belief that has only some truth.  First of all, this consideration only applies for small business owners who use their vehicle for work.  Secondly, it is perhaps more common that buying or financing a vehicle provides better tax treatment for business owners than leasing.

  • With heavy SUVs, vans, and trucks, buying is much more tax-favorable than leasing. The new generous Section 179 depreciation write-offs for vehicles weighing more than 6,000 pounds (provided they are used more than 50% for business) are only available for purchased vehicles – not those that are leased.  As a result, a business owner who purchases a $50,000 heavy long-bed pickup truck (Toyota Tundra, Dodge Ram, etc.) that is used exclusively for work can write off the entire $50,000 cost in year one.  A business owner who leases the same vehicle would only be able to deduct a small fraction of this amount.
  • For moderately priced vehicles, you’re likely to get no tax benefit from leasing. If you’re talking about a vehicle that costs $35,000 or less, then you’re likely to benefit from using the standard mileage rate deduction (not the actual cost deduction) which means there is no difference between leasing and buying for tax purposes.
  • If you drive a lot of miles for work, you’re likely to get no tax benefit from leasing. Regardless of how much the vehicle costs, those who drive a lot of miles for work are also likely to benefit from the standard mileage rate which again means no tax difference between leasing and buying.
  • For luxury vehicles (excluding heavy SUVs or trucks) that are being driven less than 10,000 miles/year for work, leasing is more tax-friendly than buying. If you’re a small business owner who wants a luxury sedan and you won’t be driving a ton of miles for business, then you are likely to benefit by using the ‘actual cost deduction’ and a larger deduction than what you would have received if you bought the car.  This is the situation when leasing can provide bigger tax benefits.

If you like to get a new car and the newest high tech car equipment every 2-3 years, leasing is a better option.

We saved the one compelling argument for leasing until the end.  For people who are determined to get a new car and all the updated car gadgets every 3 years or more frequently, leasing tends to be the better financial option than buying a new car and trading it in every three years for a new replacement.  Both of these options have significant long-term costs.  That is to say that leasing or buying a new car every three years tends to significantly impair the success of retirement plans, all else equal.  However, if someone is dead set on having a new vehicle every three years even at the expense of a deferred retirement, the economics tends to be better for leasing than buying.

Closing Remarks

As mentioned near the onset, there is a healthy amount of debate in this argument and there’s no definitive way to settle it since the economics depend on each specific situation.  All we have attempted to do here is to dispel many of the arguments that are made for leasing since most of them have no solid ground on which to stand.  

If you have a specific lease vs. buy scenario that you would like for us to evaluate, please do not hesitate to let us know.  Moreover, if you have thoughts, comments, or questions about anything above, please feel free to let us know in the comments section below.

 

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