Leasing vs. Buying a Car

More and more, I am being asked about leasing versus buying a car. I fall within the category of individuals who believe leasing is not a good idea.

I make a lease payment for three years. During that time, I have a concern about how many miles I drive. If I go over the allotted mileage, I will have to pay the penalty. At the end of the term, I have two choices:

  • I can decide to turn the car in. I will then need to start payments on a new lease or purchase a different car, probably with a car loan.
  • I can decide to keep the car, probably by obtaining a car loan and have payments on that loan for 5-7 years. By then, the car is 8-10 years old, and many individuals will say they need a new vehicle.

Either option means you are making a payment for an extended period. At what point do you get out from having a payment to have a vehicle? One of the lessons that I am hoping for individuals to learn from the pandemic is putting yourself in the situation of pledging future income to pay off past purchases is not a good idea.

Ideally, you would purchase a car with a 3- or 4-year car loan and pay the car loan in that time or even accelerate payments for a shorter term. Once the car loan is paid off, keeping the car for several years without the debt would be the goal. The recommendation would be to put that car loan payment amount in a separate savings account to accumulate for a down payment for the next car once the loan is paid off. This would mean your next car loan would be for a lower amount or that you could afford to purchase a more expensive car without increasing what you are allocating to a car purchase.

The reason many individuals choose to lease a car is that the payments are less today. Over time, they most often pay more for their transportation costs. If you cannot afford the loan payment amount for the car you want, maybe you should be considering a lower-cost vehicle. Or – another option might be to do a 5- or 6-year loan if necessary to afford a particular car.

I understand the desire to get the “better car” today. Getting a car by avoiding a loan payment and doing a lease for the lower payment is an attitude that can jeopardize your future financial security. Suppose you find yourself setting up new monthly payments for additional purchases or extended payment periods. It means increasing amounts of each paycheck are spent before you even receive the paycheck. This often fosters a paycheck to paycheck living style. It can lead to being one paycheck away from a financial disaster or the inability to handle an emergency.

Delaying the purchase of a car to give yourself a chance to save and pay a portion in cash or choosing a lower-cost vehicle today is a mindset you want to develop – not only around car purchases but around all major purchases and expenses. That means if something unexpected comes along, you are more financially prepared for it. It provides the opportunity to save for future wants – retirement, a vacation home, or some extravagant or luxury item you desire.

In general, you want to avoid promising future income to pay for products or services that depreciate or have no future value. Many individuals are called cheap because they will not spend money that they do not have. What they are often creating are financial security and less stress. Living below your means certainly has its advantages when the unexpected comes along. It also often provides a sense of peace and less stress when you know that you can handle a short-term loss of income.

Purchasing a car for cash may not be an optimal choice either. Right now, the cost of borrowing money is very inexpensive. Our recommendation for several individuals has been to leave your cash invested. With the stock market doing well right now, you are earning more on your money than the interest you will pay on the car loan. If necessary, we recommend that you take a monthly distribution from your investment account to make the loan payment if you can make the loan payment from your incoming monthly income even better.

If I borrow $25,000 to purchase a car at an interest rate of 2.50% (which is not difficult to get these days if you have a good credit score) with a 4-year loan over the course of that time, I will pay just under $1,300 for the life of the loan. If I could earn 5% on that $25,000 even with taking a monthly payment out, I would earn around $2,500 on the partial money remaining invested over the four years.

This scenario only works if you receive a greater rate of return on your money being invested than the interest rate you are paying on the loan. Leaving $25,000 in a savings account earning .25% while making the loan payments means you will pay more interest than what you will earn on your savings.

If there is a market correction or we go to a flat earnings stock market, it may put you in a situation where your loan interest is greater than what you are earning. It might become a wise decision at that time to pull the loan balance out of your investments and pay off the loan at that time.

Leveraging your cash, assets, or future income is a great way to grow wealth and become more financially secure. If you need assistance or want to talk through the best options for you when it comes to obtaining a new vehicle, please reach out to us.

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There is no guarantee that these investment strategies will work under all market conditions. Each investor should evaluate their ability to invest on a long-term basis, especially during periods of downturns in the market.

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