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To Lease or Not to Lease, That is the Question

2013 Prius Two hatchback

I just had a wonderful experience leasing a car for the first time. Isn't it beautiful? I'm starting to think of it as our turtle hot-rod since it looks nice and sporty in red. We spent the afternoon at Smart Toyota in Madison, where an excellent salesman by the name of Justin Jackson helped us through the trade-in and leasing process. I brought along an internet quote, and the negotiation process was smooth and pleasant. The hardest part of the whole process was keeping the kids under control, but they were excited about the new car and Justin was happy and accommodating the entire time. If you're in the area and looking for a car, Smart Toyota and Justin come highly recommended.

The Changing Auto Market

We decided to trade in our aging Toyota Corolla before it lost all of its value for something with better fuel economy. Right now the Toyota Prius is still the king of that hill while still having the range for longer trips, but things are starting to change rather quickly with more hybrids and electrics coming out every year. That environment of change and the fact that the Prius might be right for our family now, but not once our kids are a little bigger, contributed to our decision to lease instead of buy.

In another few years there may be a viable hybrid minivan. They already have them in Japan. Or something like the Prius V could get more fuel efficient. Or we might see more electric cars with a 300 mile range that are a bit more affordable than the Tesla Model S. That last one's probably wishful thinking, but six years out, it's a much more likely possibility. The auto market is changing faster than it has in decades, maybe even its entire history, as more manufacturers are jumping into the hybrid/EV market and competing on mileage, charge time, features, and range.

Three years ago plug-in hybrids didn't exist. Now there's half a dozen of them with more on the way. Manufacturers are converting more of their models to hybrids at an increasing rate, and once a model is a hybrid, it's a natural progression to make it a plug-in. It's becoming obvious that there are two paths to a fully electric car future. One is adding battery capacity to plug-in hybrids until the gas engine is no longer needed. The other is increasing the range and charging speed of fully electric cars until they can be useful beyond the daily commute or running errands around town. And as battery research and manufacturing gets more focus, charging times and prices are going to drop precipitously. The Nissan Leaf already shaved 4 hours off of its charge time and $4,000 off of its price in one year.

I don't think it will be long before we see more extensive use of solar panels to extend driving range as well. With panel efficiency going up and prices coming down, it will only be a matter of time before someone decides to put a bunch of them on the roof of an electric car. Seems like a no-brainer to me. With all of these changes happening in the course of months instead of years, and gas prices continuing to increase, it no longer seems like driving the same car for a decade is a rational, cost effective option.

Can Leasing Really Be a Cost Effective Solution?

Like a lot of people, I used to be very skeptical of leasing. I didn't even consider it when buying a Nissan Leaf last year, but I probably should have. I harbored a basic assumption that leasing was more expensive than buying when you're planning on driving a car until it falls apart. It seemed quite logical, but I never ran the numbers. I didn't really run the numbers in detail until after leasing the Prius either, because the changing auto market was reason enough to not want to be committed to one car for a decade or more.

I read up on leasing, mostly from, which I highly recommend, and then jumped in and tried it. I did some detailed calculations after buying the Prius, out of curiosity, and surprisingly I found that leasing three times was basically equivalent to buying a car and driving it for nine years. After that, a fourth lease may still have similar costs because the maintenance costs on a 9-12 year old vehicle can really start to add up. Here is a run down of how I came to that conclusion, starting with the total cost of owning a Prius for nine years.

How Much Does Nine Years of Prius Ownership Cost?

First things first, you'll want to negotiate the best purchase price for the car. This step is actually no different for leasing. You can use the same purchase price for buying a car and for the gross cap costs on a lease, but we'll get into that more later. I'll use for most of the pricing information, and assume that we're looking at a new 2013 Toyota Prius II with carpeted floor mats:
2013 Toyota Prius II MSRP = $25,220
2013 Toyota Prius II Invoice = $23,683
You should be able to get invoice on a Prius II that you're buying off the lot. The dealerships are overflowing with them and will be happy to let one go for that price. Now let's talk maintenance. You can buy a ToyotaCare maintenance package to pay for maintenance up to 45,000 miles. It's a good idea because it forces you to at least take the car in for recommended maintenance for that amount of time, and it costs a bit less than if you pay for it at the maintenance check-ups. It will roll into the loan so you'd be paying it over the life of the loan anyway.

The next item to consider is financing. Let's be generous and assume you can get 0.0% APR financing for 60 months. The ToyotaTime sale just ended, and that was the financing deal they were running, so it is possible to get it if you wait for the right time. Taking into account Madison's sales tax of 5.5%, we get a purchase price and monthly payments of:
Invoice plus ToyotaCare plus Sales Tax = ($23,683 + $650) * 1.055 = $25,671
Monthly Payments = $25,671 / 60 = $428
I'm ignoring title and license fees since they are the same between buying and leasing, and I'm assuming you can get away with no down payment on the loan. If you need a down payment, that's going to make buying look worse, as you'll see later.

The loan takes five years to pay off, but we're planning on keeping the car for nine years. Assuming we drive 14,000 miles per year, the car will have 126,000 miles on it when we sell it. During that time it will need three major maintenance check-ups, tires, brakes, and some miscellaneous repairs:
Winter Tires = $500
60,000 Mile Service = $300
New Tires = $400
90,000 Mile Service plus Brakes & Repairs = $800
Miscellaneous Repairs = $700
120,000 Mile Service = $300
Total Maintenance = $3000
Finally, to assess what a nine year old Prius would sell for, we can check back at and look at a clean 2004 Prius trade-in with 126,000 miles:
2004 Prius with 126,000 miles in clean condition = $4575
Total Cost = Total Purchase Cost + Maintenance - Trade-in = $24096

How About Three Leasing Terms?

Leasing is a little more complicated in some ways, but less in others, specifically in the maintenance area. If you always purchase the maintenance plan, you'll pay no service fees and the car is always under warranty for the length of the lease. To calculate leasing costs, we need to figure out the monthly payments. These payments will consist of a depreciation fee and a finance fee. The depreciation fee pays for the difference between the value of a new Prius and the residual value after the lease term. The finance fee is basically the interest rate on the depreciation fee.

First, the depreciation fee is determined by the net cap cost, the residual value, and the lease term. The net cap cost is the negotiated purchase price plus an acquisition fee for the lease plus any other price adders like maintenance agreements or gap insurance. Sometimes gap insurance is built into the lease. If it's not, you should buy it because you're only financing the depreciation cost of the vehicle. If you total it in an accident, you're going to owe a lot of money. Toyota was also offering a $500 trade-in rebate that gets subtracted from the cap costs. The residual value is normally determined by the auto manufacturer, and it is their best estimate of what the vehicle will be worth at the end of the lease. It correlates closely with assessment of a three year old Prius in clean condition:
Net Cap Cost = $23,683 + $650 + $650 + $695 - $500 = $25,178
Residual for 2013 Prius II with 45,000 miles = $14,762
Depreciation Fee = (Net Cap Cost - Residual) / Term = $289
The residual is interesting because this price is also the price you would pay at the end of the lease to purchase the car. If you decide you want to keep the car, this is the price you will pay, guaranteed. You won't be able to find an equivalent used car at the same price if the auto manufacturer was right about the depreciation. If their estimate was high, you can turn the car back in and they will have to deal with the car at its lower value. You ended up paying less on the lease than you should have, and it will be their loss. More likely their estimate was conservative to reduce their risk, and the car is worth more than the lease residual. You can trade in the car for some extra cash at the end to put towards the next lease.

The finance fee for the lease is determined by the net cap cost, residual, and money factor. The money factor is equivalent to an interest rate if you multiply it by 2400. That's an artifact of how business leasing is done with depreciation tables, but for our purposes we can just plug it into a formula. Normally money factors are a really low number because its multiplied by the sum of the net cap cost and residual to get a monthly finance fee. You can get an even lower rate during seasonal sales with leasing deals. ToyotaTime offered a money factor of 0.0002:
Finance Fee = (Net Cap Cost + Residual) * Money Factor = $7.99
Monthly Payment = (Depreciation Fee + Finance Fee) * Sales Tax = $313
Total Lease Cost = Monthly Payment * Term = $11268
Notice that we're only financing and paying sales tax on the difference between the purchase price and residual price, instead of the full purchase price of the vehicle. That's a big plus for a lease. Next, to determine the trade-in value, let's assume we drive 14,000 miles per year again, and that the condition will be outstanding at the end of the lease. This is much more likely over the shorter term of a lease while the car is under full warranty and maintenance:
2010 Prius II with 42,000 miles in outstanding condition = $15,767
Trade-In Value = $15,767 - $14,762 = $1,005
Total Lease Cost - Trade-In Value = $10,263
Now here is where things get interesting. The lease payments are significantly less than the loan payments for the first five years. What happens if we invest that money every month and then keep it invested for the last four years? Even if you don't actually save the money, it is a way of putting a value on having that money to use for other things instead of sinking it into a vehicle that's losing value. Using an online savings calculator:
Savings per month = $428 - $313 = $115
Savings Over 9 Years Invested @ 8% Minus Principle = $11624 - $6900 = $4724
Total of 3 Leases - Capital Gains = 3 * $10,263 - $4724 = $26065
So three leases costs only $1969 more than buying and $3385 of the leasing cost is extra gap insurance and maintenance plans, which add real worry-free value. Plus, you're getting to drive a car that's always less than three years old and has the latest safety features, comfort improvements, and mileage gains. At this point leasing is already looking better than buying, but the costs are basically equivalent.

What Could Tip the Balance?

There aren't many things I can think of that could make the lease worse than it is. As long as you're careful about the lease terms, it offers a very stable stream of payments with no surprise costs. That alone is quite valuable because your monthly payments will be entirely predictable, and you can budget for them. They are a known quantity, and they are guaranteed to be lower than loan payments for the same car because you are effectively spreading payments over nine years instead of five.

Even if you get in a bad accident, the lease should be the least of your worries, as long as you have gap insurance. The health and safety of everyone involved would be the primary concern. The worst that would happen with the lease is the car would be scrapped and you'd have to start over with another lease. Hopefully you could still get approved for another one. If that same accident happened on a loan, you'd have to start over with a new loan on a new or possibly used car, at significant cost to you.

There are hidden costs and risks all over the place when buying a car. Here are the ones I can think of:
  • You can't get 0.0% APR. Even if you can get 1.9% APR, that removes the last of the savings for the buy scenario above because you're paying an extra $1,255 in interest and your monthly payments are higher. If that extra money was invested instead, it would amount to another $840 so the higher interest rate would cost you a total of $2,095.
  • You need to give a down payment. Not only do you need to pony up that cash at signing, but you also could have invested that money instead. I'm not going to go through that calculation in full because it would lower the monthly loan payments and change all of the figures above, but consider that a down payment of $2000 invested at 8% for 9 years will net you $2100 in interest. The basic rule of thumb is you want to save more now, if you can, and spread spending over as long a period of time as possible.
  • The car is worth less than anticipated. A lot can go wrong in nine years that is completely out of your control. Accidents, dings, dents, scratches, and faster depreciation can all reduce the value of your car. These things can affect a lease, too, if they fall under excessive wear and tear, but if you get these things repaired, return the car in good condition, and it loses value faster than expected anyway, the leasing company will have to eat the cost.
  • Something goes wrong outside of warranty. Again, a lot can go wrong in nine years, and six of those years are outside of warranty. If mechanical problems start to crop up after the warranty is done, repairs can get very expensive in a hurry, and you have to come up with the money all at once instead of having regular monthly lease payments.
  • Gas prices keep going up. With leasing, you have the ability to trade-in to a more fuel efficient car every three years. The savings in fuel costs could easily make the switch worthwhile.
  • Cars are getting more efficient. As I said at the beginning, in a few years you may be able to lease a fuel efficient hybrid or electric car that didn't even exist before. If you bought your car intending to drive it into the ground, you'll have to try trading it in or live with the car you have as gas prices rise and newer cars get more fuel efficient and cheaper.
After considering the downsides of leasing, I figured that almost all of them are intangible or don't apply to my situation. Your circumstances may vary, but as long as you have good credit, are going to drive within the mileage limits, and are comfortable committing to a lease for three years at a time, you'll probably find that leasing is at least as good, if not better than buying in financial terms. This finding caught me by surprise. I chose to lease this time to avoid the hassle of trading in cars more frequently to keep up with new developments. The added comfort of knowing I quite likely won't lose money in the process, and I have predictable, low risk monthly payments, all combine into a pretty sweet deal.