Deciding whether to lease or buy a new vehicle is a major financial consideration for many. When you step into the world of new cars, you immediately encounter the steepest curve of depreciation. Regardless of whether you choose to lease or buy, driving a brand-new vehicle comes with a significant financial impact due to this initial depreciation. While the choice between leasing and buying has its nuances, understanding the lease-end purchase option can reveal hidden value.
Many find “savings” by extending the lifespan of their vehicles. Once a lease agreement concludes, the lessee has the option to purchase the vehicle at the predetermined residual value and continue driving it. This strategy can indeed lead to financial benefits compared to entering into a new lease at the same point. Similarly, those who finance a vehicle from the outset maximize their financial advantage by keeping the vehicle for more than three years. Selling a three-year-old financed vehicle to get into a new car with another loan often negates potential savings.
To simplify the lease-versus-buy decision, especially when we set aside the complexities of EVs for a moment, the key comparison lies in the money factor (MF) of a lease and the annual percentage rate (APR) of a car loan. In today’s market, if you find a lease with a significantly subvented MF (around 0.0015 or lower) while loan subventions are absent, leasing becomes the more financially sensible route due to the lower implied interest rate.
If the MF and loan APR are comparable, leasing often remains a preferable option. This is primarily because a lease structure doesn’t necessitate principal payments, resulting in lower monthly payments than a loan for the same vehicle. While financing builds “equity” in the vehicle, it’s crucial to recognize that vehicle equity isn’t always a beneficial asset. The opportunity cost of this equity is that it remains tied up in a depreciating asset rather than being available as liquid cash for other uses or investments.
Alt text: Graph illustrating a steep car depreciation curve in the initial years of ownership, highlighting the significant financial impact at the beginning of a vehicle’s life, relevant to lease vs buy decisions.
The beauty of leasing lies in its optionality. A lessee retains the flexibility to convert their lease into a financed purchase at any point, capitalizing on potential equity gains. Conversely, they can choose to walk away from the lease if the residual value ends up being higher than the actual market value. However, a buyer who finances a purchase doesn’t have the same flexibility to revert to a lease-like structure. They are continually exposed to depreciation without an easy exit strategy.
Optionality and lower opportunity costs are valuable aspects that make leasing a compelling choice for the right individual. However, leasing isn’t universally advantageous. If the MF is excessively high, such as with certain luxury or high-demand vehicles like a G-Wagon, leasing becomes less attractive. Conversely, exceptionally low MF leases are generally favorable.
Electric vehicles (EVs) introduce another layer of complexity. Initially, government incentives like the $7,500 tax credit often seem to favor leasing, as these credits are typically passed through to the lessee. However, lease programs for EVs frequently come with inflated money factors to counterbalance these incentives, as seen with programs from manufacturers like Mazda and Volvo. In such cases, a strategy of leasing initially to capture the incentive, and then buying out the lease with a loan, can be optimal.
On the other hand, some EVs are experiencing rapid depreciation, leading to disastrous real-world residual values, as seen with models like the Mercedes-Benz EQS and Audi e-Tron. In these situations, automakers often subvent lease residuals to make leasing more appealing. For consumers, leasing in these scenarios becomes highly advantageous, as it effectively shields them from the brunt of rapid depreciation. Exposing oneself to such depreciation through purchasing might not be financially prudent.
Alt text: Side-by-side comparison chart of typical monthly payments for leasing versus buying a car, illustrating potentially lower payments associated with leasing due to different payment structures.
In conclusion, the lease-versus-buy decision for new vehicles primarily boils down to a careful comparison of the money factor against the loan APR, and how specific usage scenarios might be influenced by residual values. For those aiming to minimize expenses, the most effective approach is often to maintain and operate a vehicle well beyond the typical lease term or loan period.
For further insights and calculations to aid your lease-versus-buy decision, resources like the LH calculator (Leasehackr Calculator) can be invaluable. These tools allow for a direct financial comparison, although they may not yet fully incorporate opportunity costs or long-term repair and maintenance expenses into their calculations.
