Should you buy or lease a car? This is a question that we hear often and as usual, the answer is that “it depends.” Additionally, I could write a whole book about this response.
Let me start by giving you the personal finance tip that is the most applicable: if your options involve a new car, you should choose either. In the first year, a car’s value drops by 15% to 20%. Someone else should take this big of a hit instead of you. Having said that, the majority of you who know me can probably accuse me of being a hypocrite because I haven’t bought a used car since I was in college. Nothing compares to leaving the dealership in a brand-new car with that intoxicating new car smell.
We can now discuss the specifics of whether you should lease or buy the new car since it has been established that you are purchasing it against my advice. You must first comprehend that the fundamental tenet of leasing is that it is just another way to purchase the vehicle. The car is not being rented from the producer. Because it’s so simple to fiddle with the numbers and increase profits, car dealers adore leasing vehicles. You, the buyer, must comprehend how lease calculations are made.
Consider a traditional loan to get a better idea of how leasing functions. The purchase price of the vehicle (less any down payment, etc.) is what you owe at the start of the loan. You will have paid back the loan in full. Similar to a loan, a lease requires you to pay the residual value specified in the lease at the end of the term. You are required to give them this value at the end of the lease, either by returning the vehicle or by paying them the residual value. When viewed in this light, a lease is comparable to a purchase with a balloon payment due at the end of the term.
Closed end leases are the majority of car leases in existence today, and that is what I will talk about here. Verify that a lease is a closed end lease before signing if you are thinking about taking one out. Because the residual value is predetermined at the beginning of the lease, in a closed-end lease the leasing company assumes the risk of the depreciated value. You can still purchase the vehicle for the predetermined residual value if the car is worth more at the end of the lease than the predetermined value. You can choose to return the car and the leasing company will pay the difference if the vehicle’s value is less than the predetermined amount.
Advantages to Leasing:
Better monthly cash flow can be obtained through leasing. This may be advantageous if you enjoy the advantages of leveraging both yourself and your investments. Why would you leave your money in a locked account when you could invest it into an investment that would yield 15%, 20%, or even more when you could only save 7% in interest? The same is true if you pay cash to purchase a car. Why would someone lock up $35,000 in cash when they could make much better returns? Despite this, few people invest in things that consistently produce these returns. In addition, 90% of those who intend to use this leverage at the start of the lease never do. Ultimately, they use the funds for other, short-term expenses. If you intend to use leverage, make sure to put it in place right away and follow through with your plan. Since the majority of people lack the willpower to adhere to the investment plan, I do not advise most people to do this. If so, it would be better for them to purchase rather than incur additional interest costs.
The majority of leases include gap insurance at no additional cost. Gap insurance, put simply, pays the difference between what you owe on a car and what it is worth. This gap will typically exist if you finance a car traditionally or lease it; however, the gap is typically larger when you lease because a smaller portion of your monthly payment goes toward reducing your financed balance. If your lease stipulates gap insurance, the insurance would pay the equity discrepancy if an accident results in the total loss of your leased vehicle. You would have to cover the difference on your own if you had financed the car. Despite the fact that this seems like a significant benefit for leasing, be skeptical. How frequently does a person actually total their vehicle and use the gap insurance? I would say not very frequently. Even though it is typically advantageous to lease, I wouldn’t base my choice on the gap insurance. Few banks provide gap insurance with conventional loans, despite the fact that it is not common.
Taxes. If the vehicle is being used for business purposes, you may be able to deduct some of the associated costs. The Luxury Automobile Depreciation Limits provided by the Internal Revenue Code set upper limits on the amounts that may be written off when purchasing a vehicle. These limits range between $2,850 and $5,200 for the first three years that the car is in service, depending on how long it has been in service. Depending on your percentage of business use, you can deduct the entire lease payment when you have a lease. This deduction may be considerably greater than what you could claim for a purchase. To find out if you qualify and what deductions you might have, I advise speaking with a tax advisor.
Advantages to Buying
Long-term Cash: With a purchase, the long-term cash outlay is almost always lower. This holds true whether you want to buy a new car every three years or every ten. The cost can be significantly lower if you purchase the vehicle if you intend to keep it for a long time. Traditional financing is a viable option if you prefer to own a car that is completely paid for with no further payments. It is the quickest method of doing away with a monthly payment.
Mileage: If you buy the car, you can put as many miles on it as you’d like. Your ability to log as many miles as you want on a leased car is constrained. The majority of leaseholders—10% of them—exceed their annual mileage limits, and it’s not unusual for them to do so by 5,000 miles. At a rate of 15 cents per mile, this could result in extra payments totaling well over $2,000 at the end of the lease. Your annual mileage is affected by a wide range of factors. Before deciding to lease a car, make sure to look at them.
Taxes. If the vehicle is being used for business purposes, you may be able to deduct some of the associated costs. The full cost of equipment purchases made in the current year may be written off by qualifying businesses under Internal Revenue Code Section 179 (up to $128,000 in 2008, including up to $25,000 for qualifying automobiles). The issue with cars is that they are frequently not thought of as equipment. They must have a minimum gross vehicle weight of 6,000 lbs (as determined by the manufacturer) in order to be eligible. If you’re looking for an SUV or truck to use for your business, be sure to check the weight and ask your tax advisor if your company qualifies.
Buy or Lease?
Both options, as you can see, have benefits and drawbacks. In addition, not everyone will be affected by all of the benefits or drawbacks. Generally speaking, I think most people would be better off purchasing the car because most people lack the financial discipline to effectively utilize their monthly cash flow savings. To help you choose which option is best for your situation, as with any major decision, I would advise getting advice from your tax and financial advisor.
(c) 2008 Bordeaux & Bordeaux, CPAs, PA
Required US Dept of Treasury Circular 230 Disclosure: Any written advice concerning one or more federal tax issues arising from any entity, plan or arrangement that concludes at a confidence level of “more likely than not” (i.e., a greater than 50% likelihood) that the subject matter of the advice would be resolved in the taxpayer’s favor if challenged by the IRS, and that avoiding or evading any taxes levied by the Internal Revenue Code (IRC) is the main or significant purpose of the topic. This article’s advice was not created to be used, and no one else or organization may use it to try to avoid paying fines under the Internal Revenue Code or any other applicable federal, state, or local tax law.
