Jim'sMoneyBlog

Financial Opinion and Insights

Should You Buy or Lease Your Next Car?

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

This is a question people often ask.  If you’re one of them, I hope this will help simplify your decision making.

First, it’s important to understand just how leasing differs from buying – Now, I’m going to ‘make up’ my own numbers here, just for the sake of illustration.  You can get your own.

Let’s suppose a car could be purchased for $35,000.   If buy the car, you would be buying 100% of the equity… all $35,000 worth.  It doesn’t matter if you pay cash or finance it; you’re still buying ownership – all $35,000 worth of equity.  If you’re financing, you would be financing that equity over a certain period of time.

For example, If you have great credit and can get a low rate, say 2.9%, and financed the car over five years, you would be making payments of $625.83 monthly, assuming no down payment.

But a lease is different.  You’re not buying the equity.  You’re simply paying for the ‘use’ of the car. 

Translation:  You are financing the depreciation.  Once the price of the car is determined (the ‘cap cost’), which we’ve stated to be $35,000, then the assumed value at the end of the lease period becomes important, because it’s the depreciation you’re paying for, not the equity.  The same car leased would likely have monthly payments around $375 simply because you’re not buying any of the equity.  At the end of the lease, you have no car and nothing to show for your money.

You can find leasing calculators all over the internet.  You’ll find that auto dealers use a ‘lease factor’.  Those who are more forthcoming will tell you what theirs is – it differs from dealer to dealer.  Just remember this formula:  Lease Factor x 2400 = the interest rate you’re being charged.  By the same token, the interest rate divided by 2400 will tell you the lease factor.

But, should you buy or lease?  It depends.

My opinion:  If you plan to change cars every three or four years, you’re probably better off leasing.  But, if you plan to keep your car five years or longer, you’re probably better off buying.  

If you’re driving a paid-for car now, what’s your rush?  Here in California, we’re in a car culture.  People are often viewed in the light of the car they drive.  Yeah, it’s stupid.  If you can fight-off trying to keep up appearances, put the monthly payments into an index fund and dollar-cost average for five years.  The market may likely buy part of your car for you!

Jim

————————

Jim Lorenzen is a Certified Financial Planner® and an Accredited Investment Fiduciary® in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors. Plan sponsors can sign-up for Retirement Plan Insights here.  IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Written by Jim Lorenzen, CFP®, AIF®

October 11, 2011 at 8:10 am