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.