Add in opportunity cost of equity in the Finance Calculator to find where leasing = loan-financing

This is going to be a long post. So if you don’t like reading, please just skip to the TLDR at the bottom.

Background: Many LH users have adopted the mindset that financing a vehicle is better than a lease; especially with the latest ICE vehicle leases being very expensive. In addition, may LH users have adopted the mindset that having positive equity in a vehicle is beneficial to long-term financial success.

The Issues:
First… users seem to ignore the opportunity cost of having zero-return cash-equity tied up in a financed vehicle. While it’s nice to “end with something”, that something took real cash and couldn’t be used for other purposes. Vehicles purchased on a loan usually have higher monthly principal + interest payments than a lease. So buyers using a loan financing will see higher monthly cash outflows into their vehicles to build that equity. However, the current LH calculator does not include this. With the opportunity cost factored in, a more complete view of the effective monthly cost can be calculated.

Second… financing is not always better than a lease in all scenarios. For financing to be cheaper, there is an inflection point of ownership duration where leasing is less economical than owning the vehicle. Typically, this inflection point occurs at a time when marginal depreciation on an older vehicle is more efficient than the depreciation in the lease structure. Is this 36 months in? 48 months? 60 months?
It would help people to know when this inflection occurs in the LH calculator.

Suggestion #1: The financing calculator should allow a person to enter in the after-tax-affected individual WACC for the equity tied up in a vehicle. This is not simply the interest return in a savings account after taxes. Rather, it is unique to each person; since we don’t know where they could deploy that excess capital (paying down credit cards, buying inflation protected treasuries, making 401k contributions, etc). In this comparison, we can simply use the monthly payment differential between the lease and financing options. A monthly compound interest calculator could easily calculate the value of these payments over the financing horizon.

Suggestion #2: Once the opportunity cost is added to the Financing “Total Cost”, the calculator can do a goal-seek type of function to establish where the monthly effective cost of the lease = financing. The tool may need a generic depreciation curve to calculate the owned depreciation in excess or 36 or 48 months. But this inflection point will inform a person how long they’d have to hold a vehicle before selling it in order to break even with the lease. I don’t think this goal seek needs to be accurate to the penny, but getting within a few bucks with rounding would be very useful.

Real World Example: Here’s a thread that Michael and Max participated in about a CX-5. Max thinks it’ll be better to own a vehicle for 4 years on a financing term than it would be to lease the vehicle over 3 years with MSDs. When entered into the LH calculator at the prevailing APR from Mazda Financial, it turns out the two approaches are almost equal on a monthly effective basis to one another.

But that’s the problem… the current LH lease calculator does not have the opportunity cost of the higher payments in the financing scenario. If someone finances over 48 months, they will be paying $339 a month more than the lease. This $339 adds up to $16,272 more paid over 48 months than if someone entered into leases and re-leased in 36 months with the same terms.

If someone’s pre-tax WACC is 6% with a 20% marginal tax rate, their post-tax WACC would be 4.8%. The $339 over 48 months on a compounding 4.8% would be $1,628 (I think… I suck at math). Adding in this opportunity cost would affect the financing total cost by $34 per month. It would then shift the break-even on the financing option to something around 52 months instead of 48.

TLDR: since many people on LH instinctively think “financing is better”, I am requesting two changes to the LH finance calculator to more accurately form a comparison. The first suggestion is to include the opportunity cost of having equity possibly trapped in a vehicle during the ownership term. The second suggestion is a goal-seek to identify the inflection point of ownership duration where the effective monthly cost is equal between leasing or loan-financing.

Also, I’m tagging @delta737h so he can correct my math. This dude maths more than I could ever math. And thanks to @Bluemkn57cars for having me think about this topic more since it’s important to attempt to objectively understand when financing makes more financial sense.

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@holeydonut Thank you for the suggestion and the thorough write-up! I have bookmarked this post for future calculator update considerations.

We need some time to marinate on it. My biggest concern is that we are making the calculator more complicated than it already is for most users (as you could tell from another post involving pre-filled RV/MF). For example, at one point we considered adding a field to capture the monthly insurance and fuel cost to reflect the true cost of ownership (useful for EV vs ICE comparison), but we didn’t move forward with it as it’s yet another field that users have to fill out when the calculator is already so daunting.

Another challenge we have is that I haven’t noticed a lot of people utilizing our Lease vs. Finance feature. Not sure if it’s because most people come here with leases in mind. Perhaps it’s time for us to produce more educational content on Lease vs. Finance.

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Maybe unlink the downpayment? This will not be exactly apples-to-apples, but one may want to put some down on financing while zero on a lease or just match the lease DAS with the same down.

Thanks for your feedback @littleviolette !

Yeah, I was trying to address the ever-increasing sentiment pervading this site against leasing. I never would have guessed that LeaseHackr of all places would be where people interested in internal combustion vehicle leases would be told to stop leasing because leasing builds no equity and leasing is expensive.

I often see “just finance it” being thrown around on this forum like candy. But I think you’re aware that for financing to be “better” (of course, “better” is highly subjective) than a lease, the owner of the vehicle will need to hold onto that vehicle for X months before selling it. Financing and selling the vehicle before X months could be worse than leasing.

Unfortunately, no one on this forum ever takes the time to figure out what that X months should be. This is exasperated where for some reason people think equity in a vehicle is a good thing. Unfortunately, equity in a vehicle has an opportunity cost; the cash to build that equity couldn’t be deployed for other purposes and could even result in the person financing taking on more expensive debt in the form of credit cards.

I think everyone on LH agrees that wanting to drive the latest and greatest cars that haven’t been farted in will cost more in the long run than a frugal alternative of driving 8 year old Honda Civics until they permanently break down. Leasing or financing new vehicles both expose the buyer to high depreciation.

I agree, a useful lease vs finance conversation would go a long way into dispelling some of the myths and false perspectives around leasing. Every other automobile enthusiast forum already derides leasing. I don’t understand why so many members on LH also want to deride leasing.

I usually match the DAS on a lease (less the first month payment) to the down payment on a financing option. That way the financing option has as close to an initial cash outflow as possible to compare with the lease.

Yes, I do the same. I think if you do the other way and select downpayment on financing, then it populates the same downpayment amount on the lease.

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Not sure where to put this, but this thread is as good as any. A colleague at work was asking me why someone would ever want to lease a car instead of financing with a loan.

I showed the LH calculator and gave the example of the Mazda CX-5 above. Showing that someone could lease the Mazda for $440 a month… or enter into a loan on that same Mazda for $779 a month on a 48 month loan.

He initially responded with - hey but if I lease then I don’t have any equity in the vehicle at the end of the 36 months of the lease. But then a few seconds later he realized that his monthly payment was $339 higher with the loan. So the higher payment was the source of that equity in the vehicle.

So he asked me… why doesn’t someone just lease the car, but then save the $339 a month difference so they have some cash at the end of 36 months to help buy out the lease instead of returning the car for a new lease? Why don’t people with leases save the extra money they’d otherwise be putting into a loan?

The only answer I could think of at that time was to say saving $339 a month in addition to paying into the CX5 lease would be a great idea. I have no clue why people leasing kind of forget to save that extra money. I guess people are just chasing low payments?

TLDR, maybe we can add some blurb in the leasing guides that chasing low payments on a lease is great, but for someone making long-term decisions, they should also set aside and save the difference between the lease payment and what they’d pay if they got a loan on the vehicle instead.

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@GOAT do this with your RS😂

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My savings are going to the therapist.

Suffering from bag holding syndrome

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lol I don’t mean people trying to collect a ton of cars.

I just meant for a “normal” person who may actually consider the option to buy out a lease and keep driving a vehicle after the lease term. Or they may dislike their car and want to enter into a new lease.

But having saved (and invested) money during the lease would represent that equity that folks find in a loan or purchased vehicle.