Buying vs Leasing A Car During Residency
Unlike other countries, mass transportation is not available in all parts of the United States due to infrastructure issues and spread out spaces. For this reason, many medical residents may face the decision of buying or leasing a car during residency. It may not be such a simple question. In fact, several times my residents have asked that I write a post on this subject matter. So, I will first define what it means to lease a car and then I will explain how I would make a decision to buy versus lease a car with multiple thought experiments and comparisons.
What Is A Car Lease?
A car lease is a hybrid between between buying and renting a car. It allows the lessor to spend a portion of the entire cost of the car over a fixed period, usually with the option to buy the car at the end of the lease period at a depreciated amount. Monthly payments are typically less than buying a car since the whole cost of the car is not included in the price. The lease cost usually includes the depreciating cost of the car and monthly interest. Additional fees may also included in the monthly bill including a cost for going over a fixed limit of miles and sometimes additional insurance costs not factored into a car that is bought. Often times, the lessor also will put down a nominal fee at the beginning of the lease period as well. Bottom line- the process of leasing a car lets the lessee enjoy a more expensive car than he/she could typically afford with lower monthly payments. But, the big question is- do they come at a significant cost?
Examples of Buying Vs. Leasing Cars
Whenever I make a financial decision, I always like to make a mental picture of the different financial possibilities. by using thought experiments. Otherwise, it can be hard to understand the subtleties of the different arrangements. So, I am going to do just that with a typical car. I am going to assume the car costs about 30000 dollars and that we are going to buy or lease the car over a 3 year period. Cars can be less costly if bought used, but for the point I am trying to make in this article, buying or leasing a new versus used car should not change the final conclusions. In my first example, I am going to assume that we are going to the hold the car we bought over 10 years and compare that to the costs of leasing for three years and buying out the lease after the 3 year period is over. So, let’s do just that…
Scenario 1- Buying and Holding for 10 Years Vs. Leasing And Buying Out A Lease
Let’s say the interest rates are 3% on both the 3 year loan for a new car and the lease. And, we are going to put down a nominal amount on the car on both the car purchase and lease- say 2000 dollars on both. So, what are the monthly and total costs of buying a car over the entire period? To determine that, I am going to use one of my favorite financial programs in the world- a very simple amortization calculator on the web from Bret Whissel called Amortization Calculator. So, the monthly payments over a 3 year period on a bought car after the nominal down payment is approximately 814 dollars for a total cost over the 3 year loan of approximately 29313 dollars. The total cost of buying the car will be 2000+29313 dollars or 31313 dollars total.
How does this compare to the monthly payments on a 3 year car lease? Let’s do the calculations. One of my favorite rules for determining depreciation of a car that approximates reality is the rule of 10+9+8+7+6+5+4+3+2+1. Each year that you own the car over a period up to 10 years can be approximated by taking the number of years that you own the car, adding the numbers from highest to lowest for that period of time and then dividing by the total of the rule (55). So in this case, the amount of depreciation over 3 years would be 10+9+8/55 or 49%. Alternatively, you can use a slightly more accurate calculator such as this one from Money-zine and come up with a depreciation percentage, which would be approximately 39%. For the sake of “accuracy”, we will use the more accurate calculator. The initial total lump sum of 3 year monthly payments are going to be (0.39) (30000-2000) or 10920 without interest. Calculating interest at a 3% rate and using the amortization calculator, the monthly payments are going to be 317.57 dollars and the total sum of payments over the three year period will be 11433 dollars.
According to the calculations, the residual value of the car is now going to be 30000*(1-0.39) or 18300 dollars. Remember the 2000 dollars that you put down on the car does not contribute to principal/cost basis of the vehicle. So, lets finance the payments of the residual value over 3 years again at 3%. The monthly payments this second time around for buying the car out of the lease are going to be about 532 dollars and the sum of the payments are going to be 19159 dollars. So, the total cost of the vehicle after leasing and then buying out the lease are going to be 2000+11433+19159 dollars for a total of 32592 dollars, not including additional leasing fees. The additional cost for leasing and then buying out the car to get the lower payments vs buying over a 3 year period is 32592-31313 or 1279 dollars total, a mild difference.
Scenario 2- Buying and Holding Vs. Continually Leasing for 10 Years
In the second example, I am going to look at the costs of leasing when you do not buy out the lease, continually leasing cars every 3 years over a 10 year period, and compare that to buying a car and holding it for 10 years. So as in our first example, the initial cost of leasing the car over a three year period is going to be 11433+2000 dollars. Let’s assume you are going to do that three and a third times over a 10 year period. So, our total costs for leasing a car continually over the 10 year period would be 3.33*(11433+2000) or 44732 dollars.
For comparison when we buy and hold a car for 10 years, there are likely going to be increased repair costs for keeping a relatively older car. Let us then go ahead and add an additional 500 dollars per year in repair costs after the initial 3 years of the loan for buying the car. We will add that to the former loan price in the prior example or 31313+(7*500) or 34813 dollars. So, the additional cost for leasing a car continually over a 10 year period compared to buying a car and holding for 10 years would be 44732-34813 dollars or 9919 dollars, almost a third of the price of a car!!!
Scenario 3- Buying and Holding vs. Continually Leasing for 10 Years With Tax Deductions
In the third example, I am going to assume that the resident is going to be moonlighting and is able to deduct the depreciated value of the car from his/her total income on an annual basis at the rate of 25%. We will again compare the costs of releasing a car every 3 years for 10 years and comparing that with buying a car and holding it for 10 years. Assuming you can deduct the depreciation from your salary, the new costs of leasing a car would be [11433 (1-0.25) +2000]*3.33 or 35214 dollars over a 10 year period. The additional cost for leasing a car continually over a 10 year period in this situation would be 35214- 34813 dollars or 401 dollars, a bit more reasonable…
Scenario 4- Buying and Selling Over 10 Years vs. Continually Leasing Over 10 Years
In this example, I am going to compare what it would cost to buy and sell a new car every three years assuming a 30000 dollar price tag for a 10 year period without leasing vs. the cost of leasing cars over a 10 year period. Most residents don’t like to have the hassle of constantly buying and selling cars, but it would be interesting to do the comparison with leasing over the same period of time. So, let’s do the calculations.
Based on our initial scenario, the cost of buying the car over each 3 year period would be 31313 dollars. So let’s assume we can sell the car over each 3 year period for 31313 dollars*(1-0.39) or the depreciated value of 19101 dollars. So, the cost over a 10 year period would be 3.33*(31313-19100) dollars for a total of 40669 dollars. The additional cost for leasing cars over 10 years vs. buying and selling cars over a 10 year period would therefore be 44732-40669 dollars or 4063 dollars, a moderate difference.
Scenario 5- Buying and Selling Over 10 Years vs. Continually Leasing Over 10 Years With Deductions
Finally, let’s compare the cost of leasing over 10 years with the ability to deduct the depreciated lease value from your taxes compared to the cost of buying and selling cars every three years for a total of 10 years. The calculations were performed in several of the scenarios above, making these calculations easy. So, the total in this situation would be 35214 dollars for leasing and 40669 dollars for buying and selling over 10 years. This is the one scenario where it would be less costly to lease for a total savings of 40669-35214 dollars or 5455 dollars total.
What Can We Conclude Based on These Scenarios?
We have crunched all the numbers and what can we conclude? The most stark difference under all these scenarios is the difference between continually leasing a car over 10 years and buying a car and holding it for 10 years. You would theoretically save a total of 9919 dollars over a 10 year period if you buy and hold a car, approximately 1/3 the value of the car. That’s a lot of money!!!
If you are able to deduct the depreciated value of the car from you income, then leasing a car every 3 years for a 10 year period will be only a slightly increased cost compared to holding on to a car for 10 years. If you like new cars, this proposition can make some sense.
Finally, the finances are almost always in favor of buying a car except for the one situation where you have to decide between leasing a car every 3 years for 10 years and buying and selling a car every 3 years for 10 years with the condition that you can deduct the depreciated lease value from your taxes because you are an independent practitioner/moonlighter/consultant. This would be a highly unusual situation.
Make sure to always crunch the numbers based upon your own inputs (these may vary slightly from mine). But, for most of you residents out there, if you need a ride to work and must have a car- go buy a car if you can and avoid the lease. A lease will put you a bit behind the eight ball over your initial working years, especially when it is most crucial to get rid of your student debt and begin your savings/investments. On the other hand, if you are able to deduct the depreciated value of the car from other self employment income, then an argument can be made to lease instead of buy. And finally, if you are in the fortunate situation of being able to walk to work every day, perhaps you can do without a car altogether and really save some money!!!