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When I graduated from business school I had certain ideas about what life should look like. I’d just spent two years at a school I loved, with really smart people, working to get a job that paid. A lot.
And the best part was that this job also gave me a 35% signing bonus.
Yep. 35% extra paid to me before I even walked in the door.
After living on a very limited budget for two years, I had finally made it. Sure, I had six figures in student loan debt. But my loan payments hadn’t started yet and I was free to spend that big bonus check however I wanted.
And I wanted a car.
Thinking I knew everything, I marched myself down to the dealership in town to test drive Audi’s. If I was getting a car, I was going big.
I test drove a few, crunched some numbers, and faced my first real decision: should I buy or lease a car?
In an accounting class I’d taken in undergrad, the professor was emphatic: you should never, ever lease a car. It’s not a good deal.
But a personal finance adage looks at this differently. It says you should lease depreciating assets (your car) and buy appreciating assets (like your house).
So should I buy or lease that Audi?
Buy vs. lease: the math
Let’s get into some numbers here. Let’s say that you can either buy an Audi for $32,500 or lease it. If you buy the car you’d need to put $3,250 down and get a 48-month loan at 5%. Your monthly payments are $695 per month.
At the end of those four years you’ve paid approximately $36,600 for the car and you own it outright. According to Kelly Blue Book estimates, your four-year-old Audi will now be worth $14,500.
If you’d leased the car for 48 months, you’d pay $463 per month lease payments after putting $3,250 down. At the end of four years, you’d have paid approximately $25,500 but you don’t own it.
Which is better? If you sell the car after four years, your total out of pocket costs would be $22,000. Your total out of pocket costs for leasing for four years is $25,500. A difference of $3,500, which is a pretty good sign that buying the car is likely the better financial decision.
Where the real difference happens
Now let’s say you want to keep the car for more than four years. If you leased the Audi, you’d lease another one at a cost of $25,500. In eight years you’ve paid $51,000 to lease two cars.
If you purchased the car and continued driving it, you wouldn’t have any additional costs other than maintenance (which can be very expensive on an Audi!). After eight years your car would have a blue book value of $8,000. In those eight years, your total out of pocket costs are $36,600 and you own an $8,000 car, which you can then sell.
Buying and holding is clearly a better financial choice.
The smart (financial) choice
So is buying the new Audi best?
Nope. Buying used, for cash, is the best financial choice that you can make.
As I was weighing my car purchase options, I came across this rule from Financial Samurai: you should only spend 1/10th of your gross annual income on a car. So if you make $50,000 per year, you should only buy a car worth $5,000. If you make $100,000 per year, you should buy a car worth $10,000.
This rule is too extreme and restrictive for most people, but I get the point he’s making: we spend too much money on cars that depreciate too quickly and for most of us they don’t add any real joy to our lives.
Author Ellen Goodman put it another (fairly depressing) way:
“Normal is getting dressed in clothes that you buy for work and driving through traffic in a car that you are still paying for – in order to get to the job you need to pay for the clothes and the car, and the house you leave vacant all day so you can afford to live in it.”
I rolled up to my first day on the job in a five-year-old Nissan Versa that I’d paid $8,500 in cash for. And honestly, I couldn’t have loved that car more. Sure, my co-workers and friends all drove more expensive cars than I did. And I sometimes felt silly valeting my little hatchback at some of the swanky LA restaurants.
But that car took me all over California, kept me safe in rush hour commute in Los Angeles, and didn’t make me feel financially squeezed.
Best of all, when we moved to London two years later, I was able to sell the car for exactly what I’d purchased it for.
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