To Lease Or Not To Lease
by the Editors of Carpoint
Leasing offers an attractive and affordable means of driving a new car every few years. However, leasing involves a number of contractual obligations so it may not be for everyone.
Leasing rather than financing or paying cash has become a popular method of acquiring a new car or truck.
It’s easy to see why. Some advertisements tempt with promises of “zero down” and low monthly payments on two- or three-year leases. Often you can lease a more luxurious car for the same monthly payment you would have if you were financing a lower-priced car. This helps explain why leasing grew in popularity during the 1990s. And even now leasing is projected to continue to account for about one-third of total vehicle sales in the years to come. What is leasing really all about? Interested in leasing a new vehicle?
What is leasing, in a nutshell?
Leasing is paying for the use of a car, rather than actually paying for the car itself. The bottom line is that your lease payments cover the cost of the vehicle’s depreciation over the length of the term of the lease, instead of the vehicle’s actual purchase price. You (the “lessee”) are expected to maintain the car during the lease, but when the lease is over you can either return the car or exercise the option to purchase it. Conceptually, that’s how it works. But in practice, there are a number of factors to consider before you decide whether or not leasing is appropriate for you.
Is Leasing right for you?
Leasing isn’t for everyone, but for those willing to accept certain limits, leasing offers an attractive and affordable means of driving a new car every few years. If you’re interested in leasing, you should make sure you’re comfortable with some of the basic aspects. Ask yourself the following questions:
Do you become easily bored with a car after only a couple of years of use? Do you feel the need to drive a new car every two or three years?
Is driving a new car more important to you than actually owning one? Are you comfortable with continuous car payments, year in and year out?
Do you maintain your car regularly, keeping it in good condition at all times? Are you comfortable with keeping your car the way it left the dealership, feeling no need to modify it way to suit your personal tastes?
Do you drive a consistent number of miles each year? Are you comfortable selecting and following an annual mileage limit?
Do you have a legitimate business use for your car? Do you plan on claiming your lease payments as a business expense?
If you answered “yes” to two or more of these questions, then leasing may be right for you.
Differences between leasing and buying
There are many differences between leasing and buying. But the primary difference is that when you buy, you’re paying to own the car; when you lease, you’re paying to use the car. Below are some specific differences between buying and leasing a new vehicle.
Monthly payments are applied to the actual purchase of the vehicle. Once the car is paid off, you’re free to do as you please with it. You can keep it for the next ten years or sell it. Buying allows you to keep the vehicle for as long or as short a period as you’d like.
Financing a vehicle usually requires a down payment. This can be in the form of cash or a trade-in.
Monthly payments are higher than monthly lease payments because they’re based on the total cost of the vehicle, not just its depreciation.
A typical financing period is 48 to 72 months. After that, you own the vehicle outright with no more payments due.
Maintenance is totally voluntary. While you should always keep your vehicle maintained for optimal performance and resale, there are no set requirements as there are with leasing.
Because finance periods usually extend beyond the typical manufacturer warranty period, maintenance costs during a four- or five-year financing period will be higher than with a two- or three-year lease.
There are no predetermined mileage limits, but higher mileage still causes greater depreciation.
There are no limits to modifications you can perform on a financed vehicle. If you like fancy wheels, you’re free to put them on.
Monthly payments are applied to the depreciation and use of the vehicle, not the actual purchase. At the end of the lease term, you can either return the vehicle or purchase it from the lessor.
Monthly lease payments for the same vehicle are lower than financing payments.
Leasing often does not require a down payment. But a down payment can be applied as a means of lowering monthly payments.
Leasing typically requires the replacement of the vehicle every two or three years. Once your lease is over, you’ll need to buy the car or lease another right away.
Early termination of the lease typically requires coming up with a significant amount of cash. Once you’re committed to a lease, you have to stay with it for the duration or come up with the money to terminate early. The early termination penalty varies from lease to lease and the method of calculating the amount is explained in the lease.
For some people, lease payments can seem endless. Once their current lease term is over, many simply start a new lease on another vehicle. Moving from one lease to another is convenient, but unless the lessee chooses to purchase the vehicle at lease-end, it often ties the lessee into a seemingly continuous cycle of leasing.
Leasing sets predetermined annual mileage limits, usually 15,000 miles per year. Additional miles can usually be purchased before the lease inception to increase the mileage limit.
Lease vehicles are usually covered under the factory warranty for the entire duration of the lease.
Lower payments and zero down…
It may sound like a dream, but leasing makes it possible. Since the amount a vehicle depreciates over a two- or three-year lease is less than the cost to finance that vehicle over the same time period, monthly lease payments can be less, and considerably so in many cases. This allows consumers to use the money they save for other things, or to lease a more expensive vehicle than they could normally afford to finance for the same monthly payment. To arrive at this monthly lease payment, a leasing institution (the “lessor”) combines the vehicle’s estimated depreciation over the lease period with the interest being paid by the lessor to finance the car, plus assorted dealer fees.
Most leases can be initiated without a down payment (known as a “capitalized cost reduction,” in leasing terms). Again, because lease payments are based on a smaller amount of money than if the vehicle is financed, less money is needed up front to initiate a lease. A down payment may be utilized in some instances to lower monthly payments to an especially attractive figure; however, this counters one of the main benefits of leasing, which is getting a new car with little money down.
Two- and three-year leases
The short lease periods available are very attractive to consumers who like the idea of driving a new car every two or three years. It also helps keep maintenance costs down by avoiding the high cost of maintenance and repairs that an older vehicle with high mileage often requires. Since most manufacturer warranties cover vehicles for at least the first two or three years with the exception of required routine servicing most serious maintenance costs get absorbed by the manufacturer anyway. Beware: those who may be thinking of terminating a lease early should think twice since there are severe penalties for early lease termination.
If you are considering an alternative method of lease termination, visit one of our featured finance providers, LeaseTrading.com.
Returning the vehicle at lease-end
At the end of the lease, you have the option of returning the vehicle to the lessor, extending the lease or purchasing the vehicle. If you choose to return it, some basic requirements must be met: 1) The vehicle must be in good shape (as determined by the lessor) and free of excessive wear and tear. Any evidence of rough or abusive treatment will result in repair costs being charged back to you. 2) The vehicle must be returned as delivered. Any performance modifications or aftermarket parts and accessories that had been installed by the lessee during the lease must be removed and the vehicle returned to the same condition that it was in when it was first leased. 3) Total mileage must not exceed the annual mileage cap set by the lease. If the vehicle has more miles than the leasing agreement stipulates (the normal mileage cap is usually 15,000 miles per year), you may be charged anywhere from 10 to 25 cents per mile for miles over the mileage cap. It pays to stay within the mileage limits.
Buying the vehicle at lease-end
If your lease includes a purchase option, you may choose to purchase the vehicle at the end of the lease. In evaluating this option, another set of factors must be considered, foremost of which is the vehicle’s lease-end value, or residual value. With the more common closed-end lease, the residual value is actually calculated at the lease’s inception. This ensures that you pay a predetermined amount regardless of the vehicle’s actual market value. If the market value is higher than the residual value, then you’re getting a good deal. If the residual value is less than the market value, the lessor not you absorbs the loss. Regardless of market value, you pay the same.
The Carpoint leasing checklist
Leasing may sound straightforward, but it is important to pay attention to the details. Here’s some advice that will help make leasing your next vehicle a little less mysterious and intimidating:
Shop around. Different dealers and manufacturers will offer different lease rates and are willing to negotiate for your business.
Read the fine print. Find out ahead of time about all hidden charges, i.e. destination, security deposit, registration fees, lease-end service charges, etc. Make sure you know the full story behind the “special” advertised price of $199 a month.
Stipulate a closed-end lease. If the actual value of the car at the end of the lease is less than its residual value, the lessor pays the difference–you don’t. Conversely, if the actual value is more, you have the option of buying the car for the fixed residual value, then selling it at a profit.
Check on insurance rates for the level of coverage required by the lessor. The lease agreement may require higher liability limits and lower deductibles than you currently carry, and both will increase your insurance premium.
Choose vehicles to lease that tend to hold their value well. The coolest-looking cars are not always the best buys in the world of leasing.
Negotiate the price of the vehicle before negotiating a lease arrangement. This prevents the selling price from influencing lease negotiation. Go into the lease negotiation with the selling price already set.
To avoid lease-end excess mileage charges, increase the mileage limit before you enter into the lease. Buying extra miles over the term of the lease is less costly than paying for the extra miles at the end.
To avoid lease-end wear and tear charges, maintain the vehicle well during the lease period. Lessors will not hesitate to charge you for perceived ill treatment.
Remember that if you decide to purchase the vehicle at the end of the lease, in the long run leasing may end up being more expensive than financing.
A glossary of leasing terms
Acquisition Fee – A fee charged by a lessor to cover the administrative costs of preparing, approving and administrating the lease. May be paid up front or included in the gross capitalized cost.
Adjusted Capitalized Cost – The amount capitalized at the beginning of the lease, after adding any fees or other charges to be included, and subtracting any capitalized cost reductions, such as discounts, trade-in allowances and cash reductions.
Capitalized Cost – Often used to refer to the negotiated selling price of a vehicle to be leased. May be used to refer to the gross capitalized cost or the adjusted capitalized cost.
Capitalized-cost Reduction – The total of any cash payment, trade-in allowance or discount used to reduce the gross capitalized cost. The capitalized cost reduction is subtracted from the gross capitalized cost to get the adjusted capitalized cost.
Captive Finance Company – A leasing or finance company that is owned by or otherwise associated with a particular vehicle manufacturer or distributor.
Closed-end Lease – A lease that allows the lessee to return the vehicle at the end of the lease term with no further financial obligation, assuming that the lessee has complied with all of the terms of the lease. The lessee may be responsible for a disposition fee, if it is part of the lease agreement. There may be additional charges according to the terms of the lease for any excess mileage or excess wear. The lessee is not responsible for any difference between the residual value, as stated in the lease, and the actual value of the vehicle at the end of the lease.
Depreciation – The amount the vehicle declines in value over the term of the lease. The depreciation may be calculated by subtracting the residual value from the adjusted capitalized cost. Using this method, the depreciation amount will also include any amounts that were added by agreement to the price of the vehicle to arrive at the gross capitalized cost.
Disposition Fee – The fee charged by the lessor if the lessee does not purchase the vehicle at lease-end, for costs associated with preparing the vehicle for resale and selling the vehicle. The disposition fee must be disclosed in the lease agreement.
Early Termination – Ending a lease before the scheduled termination date. The lessee will typically be required to pay an early termination charge as described in the lease agreement.
Early Termination Charge – The fee charged to a lessee in the event of an early termination of a lease. Penalties vary from lease to lease and the method of calculation is determined at lease inception and explained in the lease agreement.
Early Termination Payoff – The total amount the lessee owes if the lease is terminated early, before subtracting any credit for the value of the vehicle. The payoff is calculated as described in the lease agreement.
Excess Mileage Charge – The fee charged for each mile in excess of the predetermined mileage limit, as set forth in the lease agreement. The excess mileage charge varies depending on the type of vehicle, and is typically between $0.10 and $0.25 per mile.
Excessive Wear and Tear Charge – A charge collected by the lessor at the end of the lease for damage to the vehicle that is beyond what is allowed by the terms of the lease. In a consumer lease, excess wear and tear or normal wear and tear will be specifically defined.
Gap Coverage – A type of insurance coverage that covers the difference between the payoff of the lease and the amount covered by other insurance coverage, when a vehicle is damaged or stolen during the term of the lease. Most gap coverage requires that the lessee not be in default under the terms of the lease.
Gross Capitalized Cost – The negotiated price of the vehicle, plus any other amounts you agree to include in the capitalized cost, such as fees, insurance premiums, service contract premiums or prior vehicle loan or lease payoff.
Lease Term – The period of time covered by the lease agreement.
Lessee – The party entitled to possession and use of the vehicle according to the terms of the lease.
Lessor – The legal owner of the property that is leased.
Mileage Allowance or Mileage Limit – The total amount of mileage the vehicle may be driven over the term of the lease, without incurring liability for additional mileage charges.
Money Factor – A number often used by lessors to calculate the average monthly rent charge portion of the lease payment.
MSRP – The manufacturer’s suggested retail price.
Open-end Lease – A type of lease in which the lessee is responsible for the difference between the residual value and the realized value at the end of the lease. The lessee may be entitled to a refund if the realized value is greater than the residual balance.
Purchase Option – The lessee’s right to purchase the leased vehicle, either at the end of the lease or during the lease term, as specified in the lease agreement. The lease agreement may or may not include a purchase option.
Purchase Option Fee – A fee in addition to the purchase price that is required to exercise a purchase option, according to the terms of the lease.
Realized Value – A value assigned to the vehicle at lease termination. Check your lease agreement for a definition that may range from the value actually received by the lessor, the highest offer received by the lessor, the vehicle’s “fair market value,” the wholesale value or the retail value.
Rent or Rent Charge – The portion of the monthly lease payment that is in addition to the depreciation and amortized amounts.
Residual Value – The lease-end value of the vehicle, established at the beginning of the lease. This value is used in determining the monthly lease payment. The residual value is also used to determine the depreciation and other amortized amounts that go into determining the monthly lease payment.
Security Deposit – A refundable deposit, usually equal to one monthly payment, collected by the lessor at the beginning of the lease to offset any amounts due under the term of the lease.
Subvented Lease – A lease that is subsidized by the manufacturer or other lessor. Many subvented leases offer lower monthly payments by utilizing a higher residual value than other lessors, or by offering a lower rent portion of the monthly payment.