To Buy or To Lease…That is the Question!

By: Vincent A. Salvagni, CPA, CVA (Mar, 2011)

Do I lease or do I buy? It's a common question that seems like it should have a definitive answer…right? Many of our clients have asked this of us, and every time, our answer has been: "It depends". Does it bother you when you are not given a "yes" or "no" answer, or even worse when someone answers your question with a question? If so, allow me to apologize in advance. The truth is there are a number of factors to consider when determining which transaction makes the most sense for your situation. Those factors typically fall under one of two categories - financial costs/benefits and personal preferences. 

The concept of comparing leasing versus buying applies to a multitude of transactions; however, for the purpose of this article we'll discuss the purchase or lease of a new automobile.

Financial Costs/Benefits:

When you purchase a vehicle, you pay for or finance the entire asset cost and the related sales tax. Once you sign the purchase agreement and drive off the lot, your vehicle begins to depreciate and the calculation of interest starts accruing on any amount financed. Depreciation will vary depending on the market for your vehicle, and you have the ability to sell at any point going forward. When you ultimately decide to sell, whatever equity that remains in the vehicle is yours.

When leasing, you pay for the use of the vehicle over a pre-set duration of time. You don't own the asset therefore (in most states) you pay sales tax on the sum of the lease payments. The lease cost is typically derived from the normal sales price of the vehicle less the estimated resale value at the end of the lease term. The estimated resale value considers an estimate of the future depreciation of the vehicle based on the miles you will drive each year, what the age of the vehicle will be at the end of the lease, and how that particular vehicle "holds its value". You can either prepay for the lease all at once, or pay monthly payments which usually include a charge for interest. When the lease term is up, you turn the vehicle in to the dealership, sometimes subject to a fee, and the process begins again.

Whether you purchase or lease, the vehicle depreciates at the same rate. The difference between the market value for your vehicle at the time you sell (or turn in the lease) and the price that you originally agreed to is the actual depreciation.

From a cash flow perspective, you have to look at the total outflow of cash over a period of time. Certainly, lower payments on a lease compared to a term loan on a purchase saves cash in the short term. As the warranty follows the vehicle and not the method of purchase, repair costs are usually similar for either transaction during the warranty period. Over the mid-term, the net costs of the two transactions become more similar as the potential turn-in and new lease fees offset the higher payments and lack of warranty of the term loan purchase. In the long-term, provided you are not plagued with repair bills and you drive your vehicle for a number of years after it's paid off, the cost of buying a vehicle can be less than that of a lease. Complicating both situations is what you do with the cash that you save. The person that leases should invest the monthly cash savings to produce the greatest return in the short term. The buyer should continue to invest the term loan payment after the loan has been paid off in order to maximize their savings. If one chooses to invest while the other does not, either scenario can have a different outcome.

So from a financial standpoint, you can see that…"It depends"…

Personal Preference:

Personal preference seems to be the rationale that justifies the decision to lease or buy. If I want a new car every few years that's under warranty, and I'm okay with always having a car payment, I can use the short-term analysis from above to rationalize why I lease. If I take good care of my vehicle and am able to maintain equity over time with minimal repair costs, and I'm okay with not always having the latest and greatest, then I can look to the long-term analysis to show how I am smart with my cash. The lifestyle you've chosen, your financial situation and what's important to you ultimately dictate your choice. What makes sense to me may seem illogical to you.

So where does that leave us? There are hundreds of financial calculators all over the internet that show you the benefits of both leasing and buying; however, from what I've seen, none of them are able to predict the future. In every financial decision, you have to look beyond the numbers and quick answer calculators and ask yourself if you've considered all parts of the equation. We'd be glad to help you analyze any of your future endeavors so that you can continue to focus on what's important to you.

 

The information reflected in this article was current at the time of publication. This information will not be modified or updated for any subsequent tax law changes, if any.

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