If I buy a vehicle, at the end of 4 years I have an asset, If I lease I have nothing.
We would agree with the critics, that at the end of 4 years, if you purchase a vehicle you have an asset. What these critics conveniently forget to tell you, is that you have paid several thousand extra dollars in order to own this asset.
Let’s look at an example of a 2011 Toyota Camry XLE V6. You could purchase this vehicle for $29,232 or lease it for $445.94 for 48 months. We are assuming sales and use tax rates of 6%. If you are a typical American, you will finance your purchase and put no money down. To make the math easy, let’s assume that you make a down payment of $743.44 on your loan (this matches your upfront fee on your lease). You will thus borrow $30,242.48. If you obtain a 48 month loan at 5.99% to match the lease term, you will have a loan payment of $710.11. Your monthly lease payment will be $264.17 less than your monthly loan payment.
If you lease this vehicle, you will have an initial lease fee of $743.44 (which includes license & registration and the first lease payment) plus 47 additional payments of $445.94, for a total expenditure of $21,702.62. If you purchase the vehicle you will make 48 loan payments totaling $34,085.28 plus the down payment of $743.44 for a total cash outlay of $35,092.89. This is a difference of $13,390.27.
So we would agree with the statement, that if you purchase the vehicle you will have an asset at the end of 4 years, but if you lease you will have nothing, except the $13,390.27 that you would have saved over the 48 month period.
Table 1: Total Cash Outlays
Hopefully you will now be ready to admit that these critics didn’t give you the whole story. But maybe you still want to argue that the asset that you own is worth more than the $13,390.27 that you have saved. When calculating the lease, we assumed a residual of $14,921. We will leave the argument of whether your vehicle will really be worth $14,921 at the end of 4 years for another time and place. For now we will agree that the $14,921 residual is $1,530.73 more than the $13,390.27 that you would have saved over the 4 year-period. So, are the naysayers still correct that leasing is a bad choice since you are over $1,500 in the hole if you lease?
The $13,390.27 results from a monthly lease payment that is lower than your monthly loan payment, and gradually builds up over the 4 year-period. If you took your savings and just put it under the mattress for 4 years then we would agree that you would come out behind by leasing. But most people would probably have a better use for the money than just letting it sit there doing nothing. Let’s look at some alternative uses of your money and see what they do for the equation.
Table 2: Total Cash Available
- Pay off Credit Card Debt – The average American has several thousand dollars in credit card debt. Let’s assume that you are paying 18% annual interest on your credit cards, and you take your extra $264.17 and make extra payments on your credit card. At the end of 47 months your credit card debt will be $17,845.20 less, and you will have an extra $710.11 the 48th month (remember there is no lease payment the last month since you made your payments in advance) for a total of $18,555.31. This is an impressive $4,264.31 more than the residual of the vehicle.
- Invest in a Prepaid Tuition Plan – Do you have any children under the age of 18? Have you already put aside enough money to pay for their college education? I’m sure that many of you answered yes to the first question and no to the second one. College tuition continues to increase at a rate well in excess of inflation. Increases of 10-15% per year are not unusual. Most states now have some type of prepaid tuition plans. Let’s assume that tuition continues to increase 10% annually. If you invest your $264.17 in a prepaid tuition program you will have $15,122.41 at the end of 47 months, plus $710.11 for a total of $15,832.52. This will go further towards paying for college than purchasing a car and hoping that you can sell it for $14,291 at the end of 4 years. In addition, most of these plans have tax advantages that can save you thousands in taxes.
- Invest in a Mutual Fund – Historically you can earn 8-12% annually over the long-term by investing in fairly low risk mutual funds. If you were to invest the $264.17 each month in a mutual fund earning 8% annually, at the end of 47 months you would have $14,526.12. Add the $710.11 savings from not making the 48th loan payment, and you now have $15,236.23, or $315.23 more than the residual.
- Increase Investments in Retirement Accounts – Invest in a mutual fund as outlined above, but do it inside of an Individual Retirement Account. This subject is too complicated to address here, but depending on your individual situation, in addition to having the $15,236.23 calculated above, you could save an additional several thousand in taxes.
- Make an Extra House Payment – Let’s assume that you have a 30 year 6% mortgage on your house. You could take your extra $264.17 each month and make extra principal payments on your house. Paying down debt with a 6% interest rate is the same as earning 6% on your money. If you take this strategy, you will be able to pay off an extra $14,667.18 which is only $253.82 less than the residual.
- Money Market Account -Let’s assume that you are very conservative and just place your extra money in a no risk money-market account. At the time that this is being written, in late August 2010, you can earn at most 2% in money market accounts. Let’s assume that interest rates eventually return to more normal levels and you can earn an average of 3% over the next four years. If you put your $264.17 monthly savings in a money market account monthly at 3% annual interest, it will be worth $13,157 at the end of 47 months. Now add in the value of the last loan payment of $710.11 and you will have $13,867.11 at the end of the 4 year period. This cash on hand of $13,867.11 is only $1,053.89 less than the residual value, which isn’t much of a penalty at all.