Deciding between leasing and buying a new vehicle is a significant financial consideration for many. When you acquire a new car, whether through leasing or purchasing, you immediately encounter the steepest part of its depreciation curve. While the choice between leasing and buying has some impact, the most substantial financial consequence stems from owning a new vehicle in the first place. This is why some prefer older, less expensive vehicles – they represent short-term transportation at a discounted price, having already absorbed much of their initial depreciation.
Many perceive “savings” in operating an older vehicle. For instance, at the end of a lease term, a lessee might choose to buy the vehicle at its residual value and continue driving it. This can appear to be more economical than entering into a new lease at that time. Similarly, someone who finances a vehicle from the outset benefits most by keeping it for more than three years. Trading in a three-year-old vehicle for a new one with a new loan often negates potential savings.
Ignoring electric vehicles (EVs) for a moment, a simple way to approach the lease vs. buy decision is to compare the money factor (MF) against the annual percentage rate (APR) of a loan. If the MF is significantly subsidized (around 0.0015 or less in the current market) and loan rates are not, leasing might be more advantageous due to the lower implied interest rate.
If the MF and loan APR are comparable, leasing often remains a favorable option. This is primarily because a lease doesn’t require principal payments, resulting in lower monthly payments compared to a loan. While a loan allows you to build equity in the vehicle, this equity can be considered a less desirable asset. The opportunity cost of this equity is that it’s tied up in a depreciating asset rather than being available as cash for other uses or investments.
It’s important to remember that a lessee has flexibility. They can convert a lease into a financed purchase at any point to capitalize on potential equity or end the lease if the residual value is higher than the market value. However, a buyer financing a vehicle cannot revert to a lease and is always exposed to depreciation without an easy exit strategy.
This optionality and lower opportunity cost are key benefits of leasing for the right individual.
However, leasing isn’t always the best route. If the MF is excessively high, as can be the case with luxury or high-demand vehicles, leasing becomes financially less attractive. Conversely, when the lease MF is very low, opting for a lease is generally a wise move.
For EVs, the initial $7,500 federal tax credit often seems to favor leasing. Yet, lease programs for EVs sometimes incorporate higher money factors to partially offset this incentive (as seen with some Mazda and Volvo programs). In such instances, a strategy of leasing initially and then buying out the vehicle with a loan can be effective.
Furthermore, the real-world residual values of some EVs have been remarkably poor. In these cases, automakers might subsidize lease residuals (like with the Mercedes EQS and Audi e-tron). Exposing oneself to rapid depreciation through purchasing in these situations is generally unwise.
In summary, the core decision between leasing and buying new vehicles often boils down to a comparison of the money factor versus the loan APR, and how specific circumstances might be affected by residual values. For those aiming to minimize expenses, continuing to operate a vehicle well beyond the typical lease term is a sound financial strategy.
For a more detailed comparison of leasing versus buying, resources like the LH calculator can be valuable tools. These tools help analyze the financial aspects of each option, although they may not yet fully account for opportunity costs or long-term repair and maintenance expenses.
