With all the newspaper and TV ads devoted to auto leasing lately, you'd think leasing was a brand-new concept. It's not. What's new is that manufacturers and dealers are promoting leasing more than ever before. And it's working. Today about 30 percent of the people who drive new cars are leasing instead of buying. That's a jump from 2.5 percent a little more than a decade ago.
Why has leasing grown? Is it a fad? Are people simply being influenced by well-produced ads? Or has leasing become as good a deal as buying or even better? There's no easy answer. That's partly because leasing terms and calculations are complicated and partly because comparing buying to leasing is like comparing apples to oranges. Which one is better depends upon individual finances, circumstances and desires. We'll try to help you sort these out for yourself, so you can judge if leasing makes sense for you.
Leasing is basically long-term car rental, usually lasting two to four years. You agree to pay a leasing company a fixed amount each month to drive the car, which the leasing company owns, and you also pay for insurance and routine maintenance such as oil changes. You receive a warranty, as you would for a car you'd buy. And, as with a car you own, if you damage a leased vehicle, you and your insurance must cover repairs.
It's important to note that, unlike buying a car, leasing may mean that you will always have monthly payments. When you buy a car, the car loan is typically paid off long before the car is worn out. In contrast, leasing usually means endless payments. Although you may be able to buy the car at the end of the lease, most people who lease turn in the car at the end of the term and lease another. So the payments continue. In the long run, leasing may be more costly than buying, despite the lower monthly payments.
Then, you may wonder, why is leasing so popular? There are several reasons. With the prices of cars climbing, it has become harder and harder to afford monthly payments that will pay off a car in three years or less. And with new cars averaging about $20,000 today, loans are being stretched over four to six years. By the time you truly own a car, it may not be worth a whole lot in the marketplace. It still may be worth a lot to you, however, if it gets you where you're going and allows you to drive a car without making payments. That's something to keep in mind as you learn more about leasing.
Leasing is also popular with people who don't like driving older vehicles. They can always drive a new car needing relatively little maintenance and fewer repairs than most older cars. If you lease a new car every couple of years you can always drive a fairly new car. Although you will never escape monthly payments, the payments will be lower than they would be if you were buying a new car every two years. This is leasing's main attraction.
Leasing is a decision based on personal choice, as well as personal finances. For some people, leasing is a good idea for many reasons. For others, it's like a spin on a race track: It offers a short-term thrill, but doesn't get them anywhere in the long run. See whether or not you resemble one of the following drivers.
The Drive for Success
The Family That Stays Together
The Gilberts are trying to make ends meet on a limited income, yet they want a car that's safe, preferably with built-in child seats and both driver and passenger air bags. They fear having to pull off the road with a carload of kids, so they also want a car with a low probability for mechanical failure.
Their wants and needs add up to a new minivan that they can't possibly afford to buy. Recently they decided to lease a new safety-equipped minivan when the dealer told them about the low monthly lease payments they could make. For once, they didn't bat an eye at the price.
Living the Good Life
Bob decided to buy a less expensive car rather than leasing the truck he couldn't afford to buy. After four years of making loan payments he can afford, he's guaranteed he'll own a car and then have a few years of payment-free driving in which to save money for the truck he really wants.
The Pride of Ownership
Even though leasing ads often emphasize low monthly payments, it is critical to look beyond the monthly payment to understand the total cost of a lease. Examine the up-front and back-end fees included in the lease. And, if you don't mind doing a little math, learn how the monthly fee is tabulated to ensure you're getting a good deal. (See "Raise Your Leasing I.Q." in this chapter.) Sometimes the low payments that sounded so good in an ad can conceal hidden costs that add up to a poor deal. Check your lease for these important disclosures:
1. The car's price. Make sure the price of the car is listed on the lease. This figure, also called "capitalized cost," is similar to the sale price you would pay if you were buying the car. It is important to know the capitalized cost because it will determine how much you will have to pay each month.
2. The trade-in value. If you're trading in a car, make sure the amount you're receiving for the car is shown on the lease. It should be listed separately and subtracted from the car's price (capitalized cost), if you have "positive trade equity." (See "Trade-ins and Outs.")
If you have "negative trade equity," then you owe more on your loan than you will receive in credit for the trade-in. In this case, the amount you still owe, minus the amount the dealer is giving you for your trade-in, will be added to the capitalized cost and will increase your monthly payment. The dealer will then pay off the balance on the loan for the car you trade in.
3. Other price reductions. Make sure any manufacturer's rebate you were promised, any downpayment you're making and any discount you negotiated for the car are listed on the lease and subtracted from the car's price. Again, if they're not specifically listed and subtracted, you may not be getting as low a payment as you should.
Owe Money on a Loan?
$13,000.00 balance owed on loan before trade-in
- 10,000.00 trade-in credit from dealer
$3,000.00 total "negative trade equity"
By trading in your old vehicle, you won't receive a discount on your leased car, but you will reduce the amount you owe on your loan. In this example, the $3,000 in negative equity will be added to the capitalized cost of the car you lease. The dealer will then pay off the outstanding loan on the trade-in.
$10,000.00 trade-in credit from dealer
- 7,000.00 balance owed on loan before trade-in
$3,000.00 total credit toward your leased car, or "positive trade equity"
With the trade-in, you can pay off your loan and also get a discount toward your lease. Be sure the positive trade equity is shown on your lease contract and is applied to reduce the capitalized cost.
Consider selling your vehicle yourself rather than trading it in. That way you know exactly what you're getting for it and you may get more than a dealer will give you.
Who are the players in the leasing game? While your dealer makes all the arrangements to lease you a car, the dealer is a liaison between you and the leasing company that owns the car. You make your payments to the leasing company, not to the dealer.
1. The front end. Remember that the cost of a lease includes more than just the monthly payments. For starters, it includes the up-front payments. One of these, the security deposit, is usually refunded at the end of the lease (unless there is damage to the vehicle). Others, like a downpayment, aren't refunded.
Before you get too excited about monthly payments of $200 on a 24-month lease, for example, check to see whether you will have to make a significant downpayment. If the downpayment is $2,400, that's the equivalent of paying another $100 each month you'll be driving the car.
2. The back end. Fees tacked on when you turn in the vehicle at the end of the lease can add a big chunk of money to your leasing bill. Know your driving habits before you lease, so you'll be able to predict these back-end fees.
Charges that generally add the most to the cost of leasing are extra mileage and excess wear and tear, but there are a few others to watch for, too, such as a termination fee for ending the lease early.
* Extra mileage: You can usually drive a fixed number of miles annually (often 12,000 or 15,000) without incurring extra charges. Any more than that may cost you between 8 and 15 cents per mile. If you're not careful about this item, you can owe a lot at the end of the lease: an extra 2,000 miles a year on a 3-year lease could cost you $900. You can sometimes get this charge reduced by paying for extra mileage up front, but you won't get a refund if you don't drive the added miles.
* Excess wear and tear: Damage you do to the car beyond what's expected by the leasing company can dent your pocketbook. Many people who lease are frustrated when they get hit with a large bill for "wear and tear" at the end of the lease, especially if they feel the car is in good condition. Read the lease and understand what it says about excess wear and tear. Ask the dealer for a clear and thorough explanation of the standards that will be used to measure "excess" wear and tear, and write those standards into your lease.
* Early Termination Fee: Watch out for the termination fee, or penalty, if you decide you want to stop leasing the vehicle before the lease term is up. This penalty can be substantial several thousand dollars in some cases.
Another potential surprise is that under many leases the early termination penalty can be triggered if you "total" your car in an accident. Because the car is no longer drivable, your lease is automatically "terminated," and you're obligated to pay off the lease. While you car insurance should cover the cost of damages, it won't cover the cost of paying off the lease. You'll need "gap insurance" for that. You can purchase gap insurance when you lease your vehicle.
Finally, be sure you understand the details of the lease. Insist that the dealer walk you through it slowly. Don't be fast-talked into a deal you don't fully comprehend. Dealers currently aren't required to tell you all the elements they use to arrive at the monthly fee, but a customer-friendly dealer will.
If you feel pressured to sign a contract or are unsure of what you're signing, walk away. A good deal should still be available if you decide to return to the dealership to buy or lease a car. So take your time. Remember, Once you sign the lease, you must abide by its terms.
It's not always easy to figure out if you'd be better off leasing or buying from the start if you ultimately want to own the car. Even so, it's a good idea to try to determine which makes the best financial sense for you.
To figure out what you'd pay for a car at the end of the lease, ask for the "purchase option price," or the amount you'd pay to buy your leased car at the end of the lease. Then, add in monthly interest for financing the purchase after the lease is up. While the purchase option price may be negotiable, it's what dealers plan to charge based on the estimated value of the car at the end of the lease.
Now compare leasing to financing. First, how much of a downpayment could you make to lower your monthly payments if you buy the car? When you decide the size of the loan you'd need to buy the car, check loan interest rates offered by your banks or credit union, as well as those offered by your dealer, to make sure you're comparing leasing with the best financing deal you can get.
When the lease period is over, you can usually opt to buy the car. To decide if buying makes good financial sense, revisit the purchase option price discussed above. How does it compare with the price for a similar used car?
Sometimes the purchase option price is actually less than you'd pay to buy a similar car from a used-car dealer. If that's the case, consider yourself lucky.
Trucks, for example, were unexpectedly popular in the early '90s, and many people leasing them were able to buy them at the end of their leases for a much lower price than the same truck bought from a used-car dealer.
If your car holds its value better than was anticipated when you signed the lease, it's obviously smart to buy the leased vehicle for the purchase option price. If you don't really want to own the vehicle, but don't mind a little work, you can sell it immediately and pocket a profit.
On the other hand, if the purchase option price is higher than the market value of the car, buying it is not a sound financial option. If you want to buy the car anyway, you may be able to negotiate with your dealer to lower the price. But if the dealer won't match the market price, walk away.
Leasing terminology is confusing and intimidating. To add to the confusion, not everyone uses the same terminology. Take the following glossary with you when you shop for a lease so you have the meanings of all the terms right at your fingertips.
* Acquisition fee, or assignment fee: An additional fee charged by the leasing company. This fee usually ranges from $350 to $650 and is often included in the monthly payment. Sometimes, however, you are required to pay the fee up front.
* Adjusted capitalized cost, or net capitalized cost: The "capitalized cost" (car's price), minus any deductions to reduce the price of the car. Common deductions are the downpayment, trade-in credit and manufacturer's rebate. The adjusted capitalized cost is used to calculate your monthly payment. It is similar to the "amount financed" in a purchase transaction.
* Capitalized cost: Equivalent to the price of the car, including any add-ons, extra warranties, insurance, rustproofing, or other options that you've agreed to pay for.
* Capitalized cost reduction: Anything that reduces the capitalized cost before the monthly payment is calculated. It usually includes your cash downpayment, trade-in credit and manufacturer's rebate.
* Depreciation: The value that a car is projected to lose over the period of time you drive it. It's the difference between the adjusted capitalized cost and the residual value.
* Disposition fee: A charge by the leasing company to take the car back and fix it up for sale after the lease is up. Not all leasing companies charge this.
* Downpayment: An amount you pay up front to lower your monthly payment. It should be subtracted from the car's capitalized cost, or price, before the monthly payment is calculated. It lowers the monthly payment.
* Early termination fee: A penalty payment that may be added to the amount you owe if you terminate your lease early. This could amount to several thousand dollars.
* Excess mileage: Most leases allow for a maximum number of miles per year. Any miles driven over the limit are usually billed at between 8 and 15 cents a mile.
* Excess wear and tear: Damage done to the car beyond the expected wear and tear from driving. Excess wear and tear is usually determined by the leasing company.
* Gap insurance: If your leased car is stolen or totaled, your insurance will pay for the damage or loss. It won't help you make payments still owed to the leasing company. Gap insurance makes up the shortfall, or gap, between the value of your car and the amount you still owe on your lease, including a possible penalty for early termination of the lease.
* Gross Capitalized Cost: This is the capitalized cost for the leased car, plus the amount of any "negative trade equity" that is added to the capitalized cost.
* MSRP: Manufacturer's Suggested Retail Price, or "sticker price."
* Money factor: A number that dealers use to arrive at the interest charge for your monthly payment. Unfortunately, the number looks nothing like an interest percentage. It will be something like ".00375." For many leases, the general rule is that 2,400 multiplied by the money factor is the interest rate. Working this equation out, we see that a money factor of .00375 gives us about a 9 percent interest rate. However, not all lease companies use the same conversion factor to convert the money factor to an interest rate.
* Monthly payment: The monthly lease payments made over the term of the lease. Generally, it includes your depreciation, interest and taxes.
* Net Trade-in Allowance: This is the amount of credit the dealer is giving you for your trade-in, after taking into consideration the loan balance on your trade-in. Depending upon the amount of your loan, you will have either "positive trade equity" or "negative trade equity." (See "Examples of Negative and Positive Trade Equity" earlier in this chapter.)
* Purchase option price: What you'll pay for the car if you buy it at the end of the lease. The purchase option price is often tied to the residual value. If it is, then the higher the residual value, the more you'll pay to buy the car, should you decide to do so, at the end of the lease period.
* Rent Charge: In a lease, this is basically the total amount of interest you are paying. It is also known as the "lease charge."
* Residual value: How much leasing companies have estimated that the car will be worth after your lease is up. The residual value affects the amount of your monthly payment. Dealers have books with charts estimating the residual value, which is usually shown as a percentage of the sticker price (MSRP), and determined when the car is new. The higher the residual value, the less you will pay each month to lease your car. (See also depreciation.)
* Security deposit: Usually the same amount as one month's payment paid up front. You'll get it back if the car is in good condition at the end of the lease.
New federal regulations which take effect in October 1997 require dealers to disclose more information to consumers about the terms and costs of their lease. Fortunately, many dealers already provide most of this information. The information that must be disclosed beginning in October 1997 includes: (see the definitions above if you have questions about these terms)
2. The number, amount and due dates of your monthly payments.
3. The total amount of your monthly payments over the course of the entire lease.
4. The cost of the license, registration and taxes.
5. The gross capitalized cost (see definition) for the leased car.
6. The net trade-in allowance you are receiving for the car you trade in.
7. Any capitalized cost reduction.
8. The adjusted capitalized cost.
9. Rebates and non-cash credits.
10. The residual value.
11. A description of the insurance provided or required under the lease.
12. The warranty terms.
13. Who is required to take care of the car and pay for maintenance.
14. The standards for determining wear and tear (if the leasing company sets such standards).
15. Penalties for default or late payments.
16. Whether or not you can buy the car at the end of the lease, and at what price (purchase option price).
One lease term that dealers are not required to disclose is the money factor. However, if you decide that you want to do your own lease calculations or check the dealer's calculations, you will need to know the money factor applied by the dealer. If you want the information and the dealer will not give it to you, consider taking your business elsewhere.
The Nitty Gritty of Lease Calculations
See the "Leasing Glossary" in this chapter for help in understanding the terms used in the following section. In this section, first you'll learn how to calculate a monthly payment, then you can fill in your own calculations. You'll also want to review the lease to make sure you understand the up-front and back-end fees, as well as any other terms that you agree to when you sign the lease.
Check Your Monthly Fee
Warning: These calculations will work for most leases. However, some lease companies may use a different type of money factor and a different formula for calculating the monthly payment.
In this example, the sticker price (MSRP) was $22,000, but the customer was able to negotiate a lower leasing price ("capitalized cost") of $20,000. In addition, the trade-in credit reduced the capitalized cost by another $2,000 to $18,000. (Make sure that your trade-in credit and any other discounts are included in the calculations arriving at the adjusted capitalized cost.)
The monthly lease payment is made up of three parts: the depreciation charge; the monthly interest, or lease charge; and the monthly tax. It is calculated as follows:
Monthly payment = monthly depreciation + interest charge + tax
(If you want to know approximately what the interest rate on your lease is, in most cases you can multiply the "money factor" by 2400. This conversion works for most money factors, although some lease companies may use a different conversion factor.)
Monthly depreciation = (adjusted cap cost - residual value)/months in lease
($18,000 - $11,800)/36 = $172.22
Monthly Interest Charge
Monthly interest charge = (adjusted capitalized cost + residual value) x money factor
($18,000 + $11,800) x .00335 = $99.83
Add the monthly depreciation and the monthly interest charge. Then multiply the total by the excise tax. (We use 6.5% below. The tax varies from city to city in Texas, however).
(Monthly depreciation + monthly interest) x tax rate = monthly tax
($172.22 + $93.83) x .065 = $17.29
Total Monthly Lease Payment
The total monthly lease payment equals the monthly depreciation plus the monthly interest charge plus the monthly tax.
Monthly depreciation + monthly interest charge + monthly tax = Total Monthly Payment
$172.22 + $93.83 + $17.29 = $283.34
There you have it: your monthly payment. The calculation should be within a few dollars of the amount the dealer quoted. If it's not, insist that the dealer go over all the costs in the monthly payment. Are there any hidden costs? If the dealer can't explain all the costs to your satisfaction, walk away.
Note: Another way to calculate your monthly payment is to follow the steps on a business calculator with a lease program. If you do this, you will probably need to convert the money factor to an interest rate before you do the calculations. As a reminder, the usual rule of thumb to obtain the interest rate is to multiply the money factor by 2400.
Following is a model leasing form prepared by the Federal Reserve Board. Dealers may use a form very similar to this.
Model Closed-End or Net Vehicle Lease Disclosure
Federal Consumer Leasing Act Disclosures
Next Chapter: "Words About Warrantees"