Thursday, April 05, 2007

To Buy or Not to Buy, That Is the Question...

Based on the request of a regular reader of Money and Such, this post will be dedicated to the age old question: Should you buy a new vehicle or lease one? If you have topics you would like me to cover in future posts, please let me know and I will do my best to oblige.

Let's start with the premise. I think that buying (or leasing) a new car is a bad use of money. Simply put, a car is a depreciating asset, it is NOT an investment. As such, I don't like spending money on my car and I have been driving my 1997 Geo Prism since 1999. Unfortunately, it is pretty much at the end of its useful life, and I too will have to buy a new chariot in the near future. So my first piece of advice is: don't buy (or lease) a new car.

Of course, other people treat their cars differently. Some consider their car a hobby. Others treat it as a status symbol. Some spend so much time commuting that driving in a decrepit old vehicle like mine is simply unacceptable. Whatever the reason, if you have your mind set on a new car, should you buy it or lease it?

The answer to that question is grounded in pure economics: consider all the costs of owning, consider all the costs of leasing, and choose the lowest cost option. This Excel template will help you to consolidate all the different factors and perform the calculation for you.

Exact calculations aside, I would expect leasing to be the more expensive alternative as a rule of thumb. First, leasing is a less transparent deal than an outright sale, and more complicated deals have more places to hide nasty little surprises and fees. Second, for the dealer leasing is probably a much more complex undertaking, and as such I would expect the dealer to demand higher margins to cover his costs. Third, and most important, when leasing you "own" the vehicle at the most expensive point in the cost curve. During the first couple of years in a vehicle's life it depreciates at the fastest pace. By leasing a new vehicle every two years you are dooming yourself to repeatedly owning the most expensive part of the depreciation curve, and let someone else enjoy the milder portion of the curve. That doesn't sound like a very good deal to me.

As a final thought, I would like to propose that instead of buying a new car, you should consider buying a certified, "pre-owned" vehicle. Alternatively, I would consider buying a used car from Hertz car-sales. Hertz sells the top cars from their fleet - vehicles that typically have under 20,000 miles and are approximately one year old. The vehicles are very well maintained, and come with both a manufacturers warranty and Hertz's own short term warranty. The cars sell for a substantially lower price than an equivalent car at the used car dealership, and best of all: it's a no haggle transaction. The price quoted is the final price.

About 3 years ago my wife and I bought a nine month old Honda Accord from Hertz, and I have nothing but great things to say both about the car and about the transaction. The car even had an (almost) "new car smell".


Joel Rotem said...

Good post. Here are a few remarks/questions:

a. It is proven that the best financial option is buying a used car and driving it into the ground (could be 5-8 years before the car goes beyond economical repair)

b. I was thinking leasing may be interesting because of tax issues:

a. when you buy a car (new or used) you pay 8% tax (i live in CA) right off the bat on the whole car. This is a pure loss since you do not recoup any part of it when you sell. When you lease, you only pat tax on the depreciation (typically 30% of the car)

b. Assuming you are not a master negotiator and/or you are buying at a dealer, you stand to loose money when you buy AND when you sell. With a lease, you are looking at a one time transaction.

C. Car manufacturers often throw out great deals on leases since they get both the money on the car and the financing. It is easier for them to give you an overall better deal when they have both margins to play with

Shadox said...

All excellent points.

I can't say that I am familiar with the tax consequences of leasing a car.

Regarding losing money on both purchase and sale of the vehicle, personally I don't have a an issue because I only sell a car when it's value has basically declined to zero, so any loss is minimal. This strategy is not appropriate for everyone.

Regarding the car manufacturers. I am not sure. That is a statement that needs to be tested empirically. I am not sure that car companies have an incentive to offer a better deal on credit terms than they do on cash transactions. I suspect you could probably get a better or equal deal by buying your car outright using cash.

Living Almost Large said...

It depends. I asked this question because a friend has a leased car from a company in their name. Nice bonus perk and it's not like they are going to turn it down, so lease it is.