Buy vs. Lease
By: Gary Foreman
Dear Dollar Stretcher,
We own (make payments on) a '96 Ford Aerostar. We are not completely happy with it. We have considered selling it and leasing a vehicle for the same monthly payments. Is it a good idea to lease a vehicle or not? I have heard good and bad things about it. Of course everyone has their own opinion, but I need the straight facts. I am a cheapskate and proud of it, so I need the best overall deal I can get.
Valerie is one of the thousands of people who are trying to decide whether to buy or lease a car. And the decision she'll make will have a major impact on her financial well being for years to come. For most families, transportation is the second or third biggest expense. And once you make a decision, you've committed to a certain level of expenses for years to come.
So is it better to lease or buy a car? You'll hear arguments for both sides around the office water cooler. Let's see if we can't find an answer.
If you ask a salesperson about a lease they'll tell you that the advantage is that you're only paying for the part of the car that you "use up." In other words, if you drive a new car for three years, you'll only pay for three years worth of depreciation on the car. If you had purchased it, you'd be paying for the entire car.
To a certain extent, that is an advantage. Instead of trying to pay off a $20,000 loan in three years (with monthly payments of nearly $700), you'd be making lease payments of less than $400 per month, sometimes less if you make a large initial payment. And for many folks with stretched budgets, that can be very attractive: they can get a new car at a price they can afford.
But the advantage of leasing is also its disadvantage. Remember that you're only paying for the portion of the vehicle that you "use up." That means you don't have any ownership at the end of the three years. You literally walk away from the deal.
And that's at the heart of the decision facing Valerie. If she continues making payments on the Aerostar, at the end of the loan she'll have a van that has some value. Her family can continue to drive it without making additional payments, or they can sell it and use the proceeds to help buy a replacement.
On the other hand, they could sell the Aerostar and lease a new car. As Val said, they'd have a vehicle that makes them a little happier. But at the end of the lease they'll be expected to drive the car into the dealer and drop off the keys. They won't own any portion of the car.
If Valerie is as cheap as she says, she'll want to avoid the lease deal. Here's why: Leasing puts you in a position where you're stuck paying the maximum amount of depreciation possible.
Consider how the value of a car changes. As an example we chose a 4-door Honda Accord. It's popular and has remained relatively unchanged in the last 10 years.
A new one will cost you about $21,000 before taxes and add-ons. A 1996 model is currently worth $13,670. That's a loss of about $7,300 in the first three years (or $202 per month).
Now compare the '96 to a 1993 model. The '93 is worth $8,525, or about $5,100 less than the '96 (or $141 per month).
Finally, look at a 1990 Accord. It's still worth $5,260. That's a decrease of $3,265 over the three-year period (or $90 per month). This tells us that a car loses more value in the early years. So the most expensive way to own a car is to buy (or lease) a new one every three years. Simply put, you'll save money if you're willing to keep your cars more than three years or buy used cars.
Try looking at it another way. A lease on that Accord will cost about $400 per month. Over the three-year period you'll write checks totaling $14,400 or $4,800 per year, and have nothing to show for it at the end. If you bought the same car on a 60-month loan you'd pay $438 per month, not much more than the lease.
At the end of five years you'd have written checks for $26,280, but you'd own a vehicle that's worth $9,890. That means that you've really spent $16,390 over the five years or $3,278 per year. That's a savings of more than $1,500 per year, just for being willing to keep a car for five years.
Obviously this example has been simplified. Depending on where you live, what your credit rating is, the interest rate applied to the loan or lease and which car you choose, you'll get slightly different answers.
But one thing will remain constant. The most expensive way to drive a car is to get a new one every three years. And by leasing that's just what you're doing.
So what should Val do? If she really doesn't like the Aerostar she could consider selling it and buying a replacement. Buying a used model that's about four years old will keep the payments close to what they are today. Better still would be to keep the Aerostar until it's paid off and then trade it for something used that they would prefer.
For the frugal it's very simple. Avoid auto leases. If you want a new car, plan on keeping it five years or longer. And if you really want to lower your transportation costs, buy a car that's already three years old and keep it until it's between 7 and 10 years old. Even with repairs, you'll come out ahead. You won't look as prosperous behind the wheel, but you will be saving $100 or more each and every month. That might just help cover those rising gas prices for you!
Gary Foreman is a former Certified Financial Planner who currently edits The Dollar Stretcher website (www.stretcher.com) You'll find hundreds of free articles to stretch your day and your budget.