aaron evans

I always thought that the people who leased vehicles were those who couldn’t afford to finance and that leasing was a bit like using a credit card to pay for something you really can’t afford. Well, I’m buying a car soon so I thought I’d compare the cost of leasing versus financing: Let’s compare the cost of leasing versus owning a $20,000 car. I’ve checked around and for a car at this price, we’ll use the following lease terms:

• $200/month for the lease,
• $2000 due at signing,
• a lease length of 3 years

Let’s suppose Alice decides to lease the car under these terms. Bob, on the other hand, finances the car. Again, I’ve looked around and these figures seem to be about what Bob will pay:

• a $2000 as a down payment on the car,
• an interest rate of 6% on the remaining $18,000,
• a loan term of 5 years

Note that Alice gets a new car after her three years are up and we’ll assume she continues to pay $200/month for her next car. Every three years, Alice will once again have to pay a $2000 fee to lease a new car. Bob, on the other hand, keeps the same car and eventually owns the car after five years. Those are the major inputs needed for comparison but calculating the true cost of ownership is a bit more complex. First a leased vehicle will always be under warranty but a financed vehicle will fall out of warranty at some point midway through financing. We’ll assume that the car has a three year warranty. Bob will have to pay for maintenance three years into financing. We’ll estimate that Bob spends $600/year while the car is out of warranty to maintain the car.

Because Bob owns the car after 5 years, he can sell it and make money while Alice never owns anything (this is one of the oft-stated virtues of financing). We need to estimate the value of Bob’s car to evaluate the equity he has gained after 5 years. Typical 5-year depreciated values of vehicles range from 25% of the original price for the worst vehicles to 50% for the best vehicles. We’ll assume that Bob’s car is worth 45% of what it costs in 5 years (let’s imagine Bob buys a Honda, not a Chevy). Bob also has to pay sales tax on the car at the time of purchase while Alice does not. I’m in New Jersey, so we’ll make Bob pay 6% sales tax on $20k at the time of purchase.

A final consideration for total cost is that Alice has lower payments per month with her lease and can invest this “extra” money that Bob spends to own his vehicle. If we assume Alice and Bob have the same incomes and expenses, Alice can invest the difference of Bob’s payment and her payment. Alice pays $200/month whereas Bob pays $350/month (I used a loan calculator to determine Bob’s payments). After 5 years when Bob owns his vehicle, he can save $350 a month while he’s paying no car payment. Alice will invest $9000 ($150*60 months) with her savings while Bob will invest nothing over the five years. I used a saving calculator to estimate how much income Alice makes by opening a savings account with a 4% interest rate and putting $150 a month in the account. After five years, Alice will make $944 on interest.

This is all very confusing/elaborate but I think we’re finally at a point when where we can calculate the total cost for Alice and Bob respectively. We ignore costs that are the same for both Alice and Bob such as gas and insurance.

Alice, who is leasing, pays:

• $2000 (first payment for the lease)
• 36 * $200 (leasing payments for 3 years)
• $2000 (Alice needs a new car after 36 months and has to do the first payment again)
• 24 * $200 (two more years of leasing to reach the 5 year mark).

Alice pays $16000 to drive for 5 years and makes $944 by investing the money she saves by leasing. Her total cost over 5 years is $15056. Note that an any annual cost calculated from these numbers is slightly inflated because when Alice pays $2000 to start a lease, that cost is amortized over the entire term of the lease (3 years). In this example, we only consider the first two years of Alice’s second lease but include the full $2000 as a payment. If we really want to be technical about this, Alice’s second initial payment should be adjusted to $1333 ($2000 * 2/3) which makes her total cost to own over 5 years $14389. On average, Alice will pay a $240/month to drive her car.

Bob, who finances the car, pays:

• $2000 (down payment on the car)
• $1200 (taxes at time of purchase)
• $348 * 60 (loan payments for 5 years).
• $600*2 (maintenance for two years while out of warranty)

Bob pays $25,280 to drive the car for five years but owns the car at that time and can sell it for 45% of its original value ($9000). Bob’s true cost is about $16,280 ($25,280 - $9000) or $271/month.

So, if you’re planning on owning a car for precisely 5 years, you’ll pay less to lease than to own (by my calculations). However, if Bob doesn’t mind driving an old car, he can live without any car payment for as long as the car runs. Over this time period, the value of Bob’s car will continue to decrease and will decrease more rapidly as the car ages. After 6 years of ownership, we’ll assume Bob’s car is worth 40% of its initial value ($8000) and that he spends another $600 on maintenance but pays no car payment in the sixth year. His true cost over six years is $17880 ($25280+600-8000) or $248/month. After seven years of ownership, we’ll assume Bob is approaching 100,000 miles on his car and it is only worth 30% of its original value ($6000). His cost over seven years is $21480 (25280 + (2*600) - 6000) or $215/month.

Holy crap! Bob’s has to own his car for seven years to pay less per month on average than Alice does. What’s worse is that Alice is on her third new car! Financing doesn’t seem like such a great thing unless you want to keep your car forever.

Have I been fair? Well, Bob didn’t invest his money after he owns the car so you can argue that Bob wins in year six. Also, Bob could save a lot on insurance if he gets minimal coverage on his car whereas Alice always has to pay high rates to fully insure her new car. You may also argue that Alice will likely pay fees at the end of her lease when she returns the car. In Alice’s defense, a dealership may offer Alice very nice incentives to persuade her to lease a new car from the same dealership. Moreover, Alice will probably receive nicer treatment from her dealership (ie she’ll get a loaner when she gets the car serviced) because the car she drives is really the dealer’s car, not her car.

This entry was posted on Friday, November 25th, 2005 at 8:12 pm and is filed under Misc. You can follow any responses to this entry through the RSS 2.0 feed. Responses are currently closed, but you can trackback from your own site.