Should I Buy or Lease a Car
Photo by Jonathan Mast on Unsplash
When deciding to get a car there are many decisions to make. What color should I get? What brand should I get? In this article, we’re going to tackle the question, “Should I buy or lease the car?”
First I’m going to explain the differences between buying (a.k.a financing) and leasing. Then I’m going to give a scenario of buying vs. leasing for 3 cars: a 2020 BMW X3 xDrive 30i, a Toyota RAV4, and a base Toyota Tacoma 4 Door. I will also explain a third option: buying a certified pre-owned vehicle. After discussing these three options, we’ll take a look at what makes the most financial sense. Finally, I’ll summarize what you should do based on your circumstance.
You can use these links to jump around to the section you’re interested in.
- How does leasing work?
- How does buying (financing) a car work?
- Why are certified pre-owned vehicles a good option?
- What’s the best financial option(The 50% Rule)?
- Take-aways TL;DR (To Long Didn’t Read).
How does leasing work? Why would I want to lease?
When a manufacturer, such as Toyota or BMW, makes a new car they sell the car to a dealer for an “invoice” price. The dealer then prices up from the invoice price to the “MSRP” (Manufacturer Suggested Retail Price) or sale price; this is how the dealership makes money.
The minute you get into a brand new car and start driving, the car begins to lose value. This is called depreciation. For example, a brand new BMW X3 xDrive30i is about $45,000 from the dealer. After driving it for just 3 years, or 36,000 miles, the resale value drops to $28,000. Cars aren’t great assets because of this dramatic loss in value. Unless you own a classic car (such as a 1969 Blue Mako Shark) or a sought after discontinued car ( such as a Toyota FJ Cruiser), your car will lose value every year. When you lease a car you have to pay the dealer for the loss in value, plus some interest, for the duration, you lease it for.
Here are the lease costs broken down for the 3 cars I mentioned.
2020 BMW X3 xDrive30i
| MSRP | $45,000.00 |
| Miles | 12000 |
| Residual Value | $27,000.00 |
| Depreciation | 40% |
| Term | 36 |
| APR | 5.5% |
| Sales Tax | 7.25% |
| Depreciation | $500.00 |
| Interest | $165.00 |
| Total Monthly Payment | $713.21 |
- We start with the MSRP (this is how much the car cost). If there are any discounts or promotions, you can subtract them from the MSRP.
- When you are given 12,000 miles per year on your lease, the car is worth $27,000 at the end of your term. The value of the car at the end of the lease is called Residual Value. The Depreciation is the percent loss in value after 3 years of driving 12,000 miles/year.
- Part of your lease payment is calculated from the depreciation, which is the total loss value divided by your term ($45000 – $27000 ➗ 36 = $500 per month)
- The second part of your lease payment is the interest or APR. You pay interest on the total cost of the car, as well as the depreciation. In this case, the interest portion is $165/month.
- The final cost of the car is the interest portion + depreciation portion multiplied by the sales tax. This gives us a lease cost of $713/month for the BMW.
Here are the same calculations for the RAV4 and the Tacoma (assuming $0 down).
2020 Toyota RAV4 XLE
| MSRP | $27,000.00 |
| Miles | 12000 |
| Residual Value | $17,550.00 |
| Depreciation | 35% |
| Term | 36 |
| APR | 5.5% |
| Sales Tax | 7.25% |
| Depreciation | $262.50 |
| Interest | $102.09 |
| Total Monthly Payment | $391.03 |
2020 Toyota Tacoma 4 Door Cab
| MSRP | $27,000.00 |
| Miles | 12000 |
| Residual Value | $22,950.00 |
| Depreciation | 15% |
| Term | 36 |
| APR | 5.5% |
| Sales Tax | 7.25% |
| Depreciation | $112.50 |
| Interest | $114.47 |
| Total Monthly Payment | $243.42 |
So for $0 down, it would cost $391/month for a Toyota RAV4 and $242/month for a Toyota Tacoma. Notice that even though both the RAV4 and the Tacoma are the same price (MSRP) it’s cheaper to lease the Tacoma. That’s because after putting 36,000 miles on the Tacoma, it only drops to 85% of its original value, whereas the RAV4 drops to 65% of its original value. The Tacoma experiences much less depreciation because there’s a larger resale market, therefore the depreciation portion of the lease payment is lower. However, dealers may try and undercut you by factoring more depreciation than is actually experienced.
How does buying (financing) work?
When you buy a car, you pay up front for the entire value of the vehicle plus taxes and fees. You can pay all cash or you can borrow money in the form of a loan to “finance” the vehicle. In the case of financing a vehicle, you will also have to pay any interest. Here are the monthly payments for financing the 3 cars mentioned assuming the following:
- 3% APR (this is the interest on the loan)
- $0 down
- 60-month term
- No incentives
- 7.25% California sales tax
| Monthly Finance Payment | |
| BMW X3 xDrive30i | $867 / month |
| Toyota RAV4 XLE | $494 / month |
| Basic Toyota Tacoma | $494 / month |
Notice that the monthly payments are higher for financing a car versus leasing it. This is because you’re paying for the entire car. At the end of the loan term, however, you own the car; you no longer need to make monthly payments, but you will still need to pay for repairs.
Why are certified pre-owned vehicles a good option?
Another option is to buy a certified pre-owned vehicle. These are cars that have already been driven 10,000 to 30,000 miles, but have gone through comprehensive tests to make sure they’re “as good as new.” The benefit of this option is you get a new car for a 20-30% discount. These cars also come with an extended warranty that will apply on top of the miles that have already been driven. If the pre-owned vehicle has under 30000 miles, then the 20-30% discount you receive on a new vehicle more than makes up for the miles that have been put on the vehicle.
My wife purchased a certified pre-owned Chevy Cruze Hatchback and it was almost identical, in terms of quality and condition, to a brand new vehicle. The only difference was her vehicle was about 40% off the price of a new car and she received a total warranty of 50,000 miles. Had she bought a brand new vehicle, not only would she have had to pay more, but her warranty would have only covered 30,000 miles.
What’s the best financial option(The 50% Rule)?
To recap, leasing is when you borrow a car from a dealer for a set period of time. It’s like renting a car for 3-4 years. Financing is when you fully purchase a vehicle and then the car belongs to you.
Given that the monthly payments on a lease are lower than the monthly payments when you purchase, you can use those extra savings each month to invest. However, because you can fully pay off a vehicle in 60 months (5 years), the savings you accumulate early on may not compensate for what you will have to pay in the long term if you continue leasing.
The general rule for when it’s more financially advantageous to lease over financing is if you can lease your desired car for 50% or less of the monthly payment of buying the car. Otherwise, you may save more in the short term, but in the long term (8+ years) it would have been better if you bought.
Let’s take a look at the numbers over a 10 year period for each of the 3 cars we have discussed so far. Here are some assumptions I’m making:
- After 3 years, you will have, on average, $500/year in maintenance cost for owning your own vehicle
- You expect to make a 6.5% return on savings per year by investing
2020 BMW X3 xDrive30i
| Year | Yearly Lease Cost | Yearly Own Cost | Delta (Lease vs. Own) |
| 1 | $8,558.55 | $10,407 | $1,848.02 |
| 2 | $8,558.55 | $10,407 | $3,816.16 |
| 3 | $8,558.55 | $10,407 | $5,912.22 |
| 4 | $8,558.55 | $10,907 | $8,644.53 |
| 5 | $8,558.55 | $10,907 | $11,554.45 |
| 6 | $8,558.55 | $500 | $4,246.94 |
| 7 | $8,558.55 | $500 | -$3,535.56 |
| 8 | $8,558.55 | $500 | -$11,823.93 |
| 9 | $8,558.55 | $500 | -$20,651.03 |
| 10 | $8,558.55 | $500 | -$30,051.90 |
For the BMW X3 xDrive30i, the lease cost is $713/month ($8,558 per year) and the finance cost is $867/month ($10,407 per year). If you leased instead of buying, within the first year you would have saved about $1848. In your 5th year of leasing, you would have saved $11,545 over buying assuming your savings grew at 6.5% a year. However, by year 7, owning a car would have put you on top. By year 10, if you still held on to your BMW and didn’t buy another car, you would have been up about $30,000 compared to if you continued to lease. In this case, the lease cost is 82% of the purchase cost.
In the case of the BMW X3, you could continue to lease up to 7 years before buying would have been the better decision. Now let’s take a look at the Toyota RAV4 and the Tacoma.
2020 Toyota RAV4
| Year | Yearly Lease Cost | Yearly Own Cost | Delta (Lease vs. Own) |
| 1 | $4,692.32 | $5,930 | $1,237.35 |
| 2 | $4,692.32 | $5,930 | $2,555.12 |
| 3 | $4,692.32 | $5,930 | $3,958.55 |
| 4 | $4,692.32 | $6,430 | $5,953.20 |
| 5 | $4,692.32 | $6,430 | $8,077.51 |
| 6 | $4,692.32 | $500 | $4,410.22 |
| 7 | $4,692.32 | $500 | $504.57 |
| 8 | $4,692.32 | $500 | -$3,654.96 |
| 9 | $4,692.32 | $500 | -$8,084.85 |
| 10 | $4,692.32 | $500 | -$12,802.69 |
In our RAV4 example, the lease cost was about $391/month ($4692/year) and the purchase cost was $494/month ($5930/year). In the case of the Toyota RAV4, you could lease a car for about 8 years before buying would have been a better option. In this case, the lease cost is 80% of the purchase cost.
2020 Toyota Tacoma
| Year | Yearly Lease Cost | Yearly Own Cost | Delta (Lease vs. Own) |
| 1 | $2,921.09 | $5,930 | $3,008.58 |
| 2 | $2,921.09 | $5,930 | $6,212.72 |
| 3 | $2,921.09 | $5,930 | $9,625.12 |
| 4 | $2,921.09 | $6,430 | $13,759.34 |
| 5 | $2,921.09 | $6,430 | $18,162.27 |
| 6 | $2,921.09 | $500 | $16,921.74 |
| 7 | $2,921.09 | $500 | $15,600.56 |
| 8 | $2,921.09 | $500 | $14,193.51 |
| 9 | $2,921.09 | $500 | $12,695.00 |
| 10 | $2,921.09 | $500 | $11,099.09 |
| 11 | $2,921.09 | $500 | $9,399.44 |
| 12 | $2,921.09 | $500 | $7,589.31 |
| 13 | $2,921.09 | $500 | $5,661.53 |
If you’re able to snag a Tacoma lease for $243/month ($2921/year), even after 13 years of leasing, you would still be on top of someone who bought and financed a Tacoma for $494/month ($5930/year). For the case of the Toyota Tacoma, the lease cost is 50% of the purchase cost, so it’s more advantageous to lease long term because after 13 years (156,000 miles), someone who bought would probably end up buying another new car.
Take-aways? TL;DR
- If you’re leasing a car you’ll have to pay less in the short term, but in the long term you’re going to end up wasting money if you continue to lease. If you think you will need a car for the long term (8+ years), most likely it’s better to buy it (finance) rather than lease it. The only exception is if you can lease the car you want for 50% the monthly own price.
- If you think you’d want to have a new car less than every 7 years, it’s better if you lease. Buying a new car is financially the better option if you plan to keep the same car for at least 8 years.
- If you’re thinking about buying, consider going for a certified pre-owned vehicle. It’s almost the best of both options; you save money in the short term with lower payments, and once you pay it off it will benefit you in the long term.
On a final note, cars today are expensive – the average new car costs about $33,000. That’s a lot to spend for something that most people think of as just a means to “get from point A to point B.” In my opinion, there are only a few cars worth buying:
- C8 Corvette
- Tesla with FSD (Full Self Driving)
- TRD 4Runners or Rubicons
Otherwise, I’d recommend getting a pre-owned Honda Civic or CRV.