Financial analysis of leasing vs. purchasing a vehicle

Article | February 17, 2024

Authored by Weinlander Fitzhugh

When acquiring a new vehicle, the decision to lease or purchase can be financially significant. The choice is more than a matter of preference – it’s a strategic financial move that can impact your budget and lifestyle. In this article, we’ll analyze both choices, providing a clear, numbers-driven roadmap to make an informed decision that suits your financial and lifestyle goals. 

Leasing vs. buying: the fundamentals

An auto lease is like renting a car for a longer term. You pay to use the vehicle for a certain time and mileage. When you purchase a car, you’re paying to own it, typically through a loan. 

But the cost breakdown is a lot more than just sticker price. Whether leasing or buying, depreciation, interest, and sales tax will affect your monthly payments and total cost; however, these costs manifest differently in each option.

To illustrate the differences, let’s consider a scenario where you’ve worked out a deal to acquire a new vehicle. The Manufacturer’s Suggested Retail Price (MSRP) is $45,000, but you’ve negotiated discounts, bringing the net price, including upfront fees, to $42,000.

Financially, is it more beneficial to lease or buy the vehicle? 

How to calculate the cost of leasing

When you lease a car, you can choose the duration of the lease and the annual mileage allowance. Setting a reasonable limit is important, as you could incur additional fees for exceeding the mileage limit unless you buy the vehicle when the lease ends. For our example, we’ll use a 39-month term with an annual limit of 7,500 miles with no money due at signing.

A lease payment is based on three main components: depreciation, interest rate, and sales tax, which will be covered below.

Lease Depreciation

The vehicle’s residual value, which the leasing company sets, is its estimated value at the end of the lease. The residual is expressed as a percentage of its MSRP. For example, if a leasing company sets a residual value of 79% for a vehicle with an MSRP of $45,000, they estimate the vehicle will be worth 79% of its MSRP at lease end, or $35,550. 

If you bought the vehicle for the MSRP of $45,000, the cost of the depreciation would be $9,450 ($45,000 – $35,550), which would be factored into your lease. But, you negotiated the price of the vehicle to $42,000; thus, the cost of depreciation is only $6,450. It’s important to note that every dollar you negotiate off of MSRP is a dollar saved in your total lease payments. A rule of thumb is that every $1,000 reduction in the price reduces a lease payment by roughly $30 a month.

Considering the negotiated price, your depreciation will be $6,450 over 39 months, or about $165.38 per month. 

Lease Interest

Technically, leases use a money factor instead of an interest rate to calculate the interest portion of a lease payment. The money factor is usually expressed as a small decimal, like 0.00291, and can be converted to a comparable, but not exact, annual interest rate. To convert the money factor to an annual percentage rate, multiply the money factor by 2,400. In this case, the 0.00291 money factor equates to a comparable APR of 6.98%.

To calculate the interest portion of a lease payment, multiply the money factor by the sum of the Net Price and the Residual Price. So, for our example, we would multiply .00291 by ($42,000+35,550). This equates to $225.67 of interest per month.

Lease Sales tax

After calculating the depreciation and interest costs, we need to calculate the sales tax you’ll pay while leasing. With a lease, you only pay sales tax on the monthly lease payments, not the car’s entire value. However, some states have slightly different rules and guidelines for sales tax treatment on leases, so be sure to check with a dealer or Department of Revenue.

For our example, let’s say your local sales tax rate is 8.99%. 

We have determined that your monthly payment includes $165.38 for depreciation and $225.67 for interest, totaling $391.05 per month. 

To calculate your monthly sales tax, multiply $391.05 by the sales tax rate of 8.99%, which equals $35.16 per month.

Total cash outlay for the lease

The total monthly lease payment is calculated by adding depreciation + interest + sales tax. In our example, these add to a monthly payment of $426.21 for the lease term.

At the end of the lease, you may be charged a disposition fee if you return the vehicle to the leasing company.  Also, you may be charged for excessive wear and tear, mileage exceeding your lease’s allowance, or other fees built into the lease.

Over the 39-month lease, you would have a cash outlay of $16,622.19 plus any excess fees such as disposition, mileage, and wear and tear.

How to calculate the cost of purchasing

Now, let’s consider purchasing the same vehicle. Using the same net price of $42,000 after negotiations, you still need to consider depreciation, interest, and sales tax, but the figures look slightly different. To compare apples to apples, we’ll assume that you keep the vehicle for 39 months and then sell it.

Sales tax

When purchasing a vehicle, you pay sales tax on the full purchase price when you register the vehicle. Using the same variables from our example above, you’ll pay $3,775.80 (8.99% sales tax rate X $42,000 purchase price). 

Loan term and interest

For our example, let’s assume you finance both the vehicle purchase price plus sales tax and receive a loan for $45,775.80 at an interest rate of 6.98% for 72 months. The monthly loan payment would be $780.07. Total payments over 39 months would be $30,422.57.

Over the 39 months, you pay back $21,737.44 in principal, leaving a remaining balance of $24,037.52.

Depreciation

Your vehicle will depreciate over the 39 months, and from the lease deal, we know that the expected residual value of the vehicle after 39 months is $35,550.

For our example, we will use the residual value. However, please note that the leasing company sets the residual value, which may be influenced by factors other than the true estimated future value of the car. 

Total cash outlay for the purchase

You purchase the car and make 39 monthly payments of $780.07, totaling $30,422.57.

You sell the car for the residual value of $35,550. Your loan payoff is $24,037.52, returning $11,512.48 to you. Thus, your total cash outlay is $18,910.09 for the 39 months. 

This amount would need to be adjusted if your state allows for a sales tax credit based on the sale price of your car for the purchase of a new car. If your state allows it and you’re purchasing another car, you would gain a credit of $1,700.02 toward the sales tax for your new car.

Comparing both options

The total cash outlay for the lease is $16,622.19 as compared to $18,910.09 for a purchase.

More striking is the monthly cash outlay. The monthly payment for the lease is $426.21, whereas the monthly loan payment for the purchase is $780.07, a difference of $353.86 per month.

With a purchase, you pay sales tax on the full purchase price of the vehicle. With a lease, you only pay sales tax on the depreciation plus interest. Also, with a purchase, you pay the principal faster than the car depreciates. This is why, at the end of the 39 months, your vehicle has equity in the amount of $11,512.48. So, you have cash tied up in the vehicle when that cash could otherwise be growing in an investment account.

The importance of personalized financial analysis

Kelley Blue Book reported that the average price of a new car reached $48,451 in August of 2023, up from $37,577 in December of 2018 (a 29% increase). As new car prices increase year after year, more consumers may turn to leasing to keep monthly payments affordable for the type of car they desire. With that said, don’t shop solely on the monthly payment amount. Even though a monthly payment for a lease or purchase may seem great, the underlying deal may not be so great.

This example analysis shows the significant financial differences between leasing and purchasing a vehicle. However, it’s important to note that this is a simplified example. Real-world scenarios involve a myriad of variables.  

Additionally, these examples do not consider any potential tax savings. For instance, a vehicle purchase might qualify for 100% depreciation in the year it was purchased.

Before making a decision, conducting a detailed, personalized financial analysis is imperative. This process will help you uncover the most economically advantageous option for your situation. If you’re considering acquiring a new vehicle, especially if it will be used for business, we encourage you to contact our office to understand the potential tax benefits of your potential lease or purchase.