Lease vs. buy: the complete economic model
Key takeaways
04 · ideas- Over 5 years, buying is typically $5,000–$15,000 cheaper than leasing
- Leasing transfers the depreciation risk to the lessee — at a premium
- The money factor on a lease is the hidden interest rate — multiply by 2,400 to get APR
- Zero-down leases aren't zero-cost — they just fold everything into the monthly payment
Basic level
The essentials · 1 min
Leasing is renting a car for 2–3 years. You pay for depreciation during the lease period plus a financing charge. At the end, you return it or buy it at the residual value.
Why leasing seems attractive:- Lower monthly payment than buying
- Always driving a new car with warranty
- No concerns about resale value
- Lower down payment
- After the loan is paid off, you own an asset worth thousands
- No mileage penalties
- No wear-and-tear charges at return
- After 5 years of owning: own a car worth $12,000–$18,000 vs. owning nothing after leasing
Rule of thumb: If you keep a car for 5+ years, buying is often cheaper. Leasing can make sense if you want new technology every 3 years and value that enough to pay the premium.
Intermediate level
How it applies · 2 min
The full cost model
Scenario: $35,000 car, compared over 5 years.
Buying:- Down payment: $5,000 (14%)
- Loan: $30,000 at 6% for 60 months → $580/month
- Total payments: $34,800 + $5,000 down = $39,800
- Residual value after 5 years: ~$17,500 (50% retained)
- Net cost: $39,800 − $17,500 = $22,300
- Monthly payment: $400
- Total payments: $400 × 60 = $24,000
- Drive-off fees: $2,000 × 2 leases = $4,000
- Residual at end: $0 (you don't own anything)
- Net cost: $28,000
Buying saves $5,700 over 5 years. After 10 years (third car purchase vs. perpetual leasing), the gap widens dramatically.
The money factor decoded
Leases don't use "interest rates" — they use a "money factor." To convert:
A lease with money factor 0.0025: APR = 6%
A "good" money factor for excellent credit (750+): 0.0015–0.0025 (3.6–6% APR).
Average money factors run 0.002–0.003. Dealer markup on money factor is extremely common — always ask for the "buy rate" (what the manufacturer's finance arm charges) before dealer markup.
Mileage penalties: the hidden cost
Standard leases include 10,000–12,000 miles/year. Overages: $0.15–$0.30/mile.
If you drive 15,000 miles/year:- 3,000 over × $0.25 = $750/year overage
- Over a 3-year lease: $2,250 in penalties
- Or pay upfront: ~$0.10/mile extra = $900 total (cheaper)
Always negotiate mileage upfront rather than pay overages at lease end.
Advanced level
The math, step by step · 2 min
Deriving the true lease cost
A lease payment is fundamentally the monthly cost of depreciation + financing charge:
- Cap cost = selling price − down payment − rebates
- Residual = estimated value at end of lease (set by manufacturer)
- Money factor = APR / 2400
Optimizing the lease: A higher residual → lower monthly payment (you're financing less depreciation). Manufacturers sometimes inflate residuals to artificially lower payments. If the car's actual market value at lease end is below the stated residual, the manufacturer took a loss — and you don't benefit (the residual is locked in your contract).
The lease vs. buy NPV model:
Let C = purchase price, R_t = residual value at time T, r = financing rate, L = monthly lease payment.
NPV of buying:
NPV of leasing:
Leasing wins when NPV_{lease} < NPV_{buy}.
This rarely occurs over periods longer than 36 months because the car's residual value (which the buyer captures but the lessee forfeits) exceeds the cumulative financial advantage of lower lease payments.