Should you buy or lease a vehicle?

If you watch any amount of TV you will see more than a few car commercials. Large expenses like buying or leasing automobiles can have a significant impact on financial well-being, but these purchases are too often ignored. Let’s face it, cars are an integral and exciting part of American life. There is a great feeling that can come from driving a new car, but if your goal is to build wealth we must first consider the following points before we can answer whether it makes sense to buy or lease a vehicle. As a CFP® my goal is to help clients make the best decisions regarding their finances, and below are my recommendations on whether you should buy or lease a car. 

Point 1 - Cars are necessary to get you to your job or perform your job so that you can earn income from which you can save and invest to build wealth.

Point 2 - New vehicles, when purchased, depreciate significantly in value (especially on the day you buy it) and continues to do so throughout its lifespan.

Point 3 - A lease is essentially a long-term contract to rent a vehicle with an option to buy. There is no inherent value, but there is an opportunity cost associated with leasing.

Our Lexus

Cars can both help and hurt one’s ability to build wealth. For an example, I offer my wife’s Lexus vs our buying a new Lexus.

In 2006, we purchased a 2004 Lexus RX330 for $26,900 and paid it off early. We are still driving it. To give you an idea how old the car is, when it was originally sold George Bush was just finishing his 1st term as president and Barak Obama was still a State Senator in Illinois. Facebook was just being invented by Mark Zuckerberg in his dorm room at Harvard, and Lance Armstrong had won his 6th (of 7) Tour De France race.

I checked the Private Party Value of the car on Kelly Blue Book and the car is worth just over $6000.  So, $26,900 less $6000 = $20,900 paid (ignoring maintenance costs which have been minimal). We’ve owned the car for 14 years which works out to $168/month. That “payment” will decrease further each year we drive it. We plan for my wife to drive the car another 5 years at which time our oldest son turns 16, and he will be lucky enough to drive the then 21-year-old vehicle.

I just checked online and a 2020 RX350 currently leases for $419/month for a 36-month term with $3,999 due at signing. For simplicity let’s average the amount due at signing over the 36-month lease. That’s an extra $111/month or $530/month in total.

$530/month (cost of the lease) - $168/month (cost of our “car payment”) = $362/month difference.

Let’s assume we continue to purchase good used cars that we drive a long time that average us $168/month for the next 40 years vs the $530/month if we wanted the new Lexus car smell every three years. If we invest the difference ($362/month) and earn a rate of return of just over 7% (7.18% to be exact) we’d have an extra $1,000,000.

What smells better than that new car smell? How about a million dollars!

Sure that new car smell is nice, but is it worth $1,000,000?  The surest way to build wealth is to buy reasonable used cars, drive them as long as economically possible, and invest the difference. But that’s not the American way. For good reason, new cars are incredibly nice. I know that because I don’t have one, and every time I sit in a new car I recognize how not nice my car is. However I like no car payments better! For the record, I drive a 2010 dark gray Prius. Nothing screams cool like an old Prius (Although in the photo below you’ll see that surf racks and boards offer an attractive distraction).

First things First

It’s not wrong to buy or lease a new car, it’s just that too many Americans are buying or leasing cars when they can least afford to do so. They buy or lease cars before they have sufficient emergency savings, aren’t on track for retirement, and worse have other consumer debt (credit card and student loans). Borrowing more money to buy a depreciating asset isn’t a way to build wealth. It’s a way to prevent it. That’s not an opinion, it’s just math.

If you have an emergency fund (3-6 months’ worth of expenses), are on track with your retirement savings, have no other consumer debts, and prefer a new car smell than you can afford to either buy or lease a new car.

Buying is better than leasing but buying used is even better

So which is better: buying or leasing? If you are interested in building wealth, then buying a new car and driving it for many years is significantly better than leasing. Buying a used car that won’t depreciate nearly as much is even better!

Of course, there are a few notable exceptions:

Exception 1 

Buying or leasing brand new cars may make sense for people that can write off the purchase and reduce taxes. 

Exception 2 

My dream vehicle is a 23 window VW Van. In 1963, they cost around $2500.  As you can see in the photo a mint condition 1963, 23 Window Van sells for over $215,000. This is a vehicle that increases in value and consequently your wealth. That’s an average annual rate of return of 8.13%. Not too shabby.

New cars are an extremely tempting purchase, but if people really want to build wealth they need to take care of other debts, savings, and retirement before they consider buying or leasing a new car.

Should you have any financial planning questions, including guidance regarding large purchases, please feel free to reach out.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. They hypothetical examples listed above are not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing. Investing involves risk including loss of principal.  No strategy assures success or protects against loss. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.