Although leasing is sometimes made to sound very complex, it is just another way to finance a vehicle. A lease can reduce a person’s car payments by hundreds of dollars per month while preventing them from investing too much in a vehicle they do not intend to keep.
These benefits of leasing touch on two much larger issues; the first is the time-value of money and its potential to help you get ahead. The other is the idea you always lose money spent on vehicles. It is just a matter of how much and how quickly.
Because of this, those who trade before their vehicles are paid off cannot afford to ignore leasing.
However, it is important to understand the pros and cons of leasing and buying to determine which option is best for your lifestyle and budget.
What is a lease?
When you lease a vehicle, you only finance a fraction of the vehicle’s value for a specified term. The amount you pay is the predicted depreciation of the vehicle during the lease term, plus interest.
Leasing is much like renting the vehicle; but paying to use a vehicle, as opposed to owning it, can be very advantageous.
For instance, instead of making payments on a Ford sedan you will trade in a few years, you could lease a Mercedes or BMW for the same monthly investment.
Despite this, many people are close-minded about leasing, although their complaints about leasing also apply to buying or trading a vehicle.
What are the advantages?
For people who insist on frequently switching vehicles or maintaining a full warranty, leasing provides an option oftentimes cheaper and safer than buying.
Leasing provides a financial safety net to insulate you from drastic changes in the used car market, such as large increases in the price of gasoline, recalls or loss of consumer confidence in a brand or model. When you buy a vehicle, you are at the mercy of all these factors and can easily end up owing much more on your car than it is worth. When this happens, it can be difficult to trade.
Instead of being trapped with a vehicle, you have several options once a lease is over. You can buy your leased vehicle, sell it for a profit, or return it to the dealer and be completely free from it.
This means leasing will keep you from haggling with dealers about what your trade is worth.
The catch
Because you are essentially renting, the lease company puts certain restrictions on the condition of the vehicle when you return it, with the most common being mileage and condition. Most leases allow you 12,000 to 15,000 miles a year, but you can purchase extra miles to fit your needs.
You can also be penalized for excessive wear and tear. Because of this, you need to be clear what constitutes excessive wear and tear before signing the lease, as well as consider “wear/tear coverage,” which is a warranty to help absorb such charges.
Also, if there is no buy-out option, trading a leased vehicle before the end of the term can be difficult. However, some leases can be transferred to another party.
Common objections and their flaws
Many people refuse to consider a lease because of the possibility of mileage and wear penalties at the end of the lease. However, if you own and trade a vehicle with above average miles or wear, your trade allowance will be reduced, still effectively penalizing you for these items.
The idea of not having a car when the lease term is over can also be troubling. Unfortunately, after owning a vehicle for 36 months, most people still owe more on it than what it is worth, which is worse than nothing. A person in this situation who wants to trade, or whose vehicle is totaled, is likely to need a rebate or money down to attain financing, which usually forces them into undesirable vehicles using big rebates to attract buyers.
Others are concerned with the idea of “not owning the vehicle,” but, technically, until the vehicle is paid off, the bank has ownership, not the individual.
Another complaint is a lease requires a down payment, although this is not always true.
With a lease, there are also limitations on customization or modification, but you can lease dealer-provided add-ons as part of your lease payment. Otherwise, modifications must be removed or returned to factory condition to avoid a penalty, although the same is true when trading in vehicles.
How it works
Although leasing can be somewhat confusing, it is not much more complicated than buying, provided you understand the jargon and terminology.
Example: Here is a lease special for a 2007 Toyota Camry LE available when this article was written, with much of the fine print removed, leaving only the important figures:
MSRP: $21,794
Capitalized cost: $18,270
Lease-end purchase option: $12,375
Total payments: $7,164
Term: 36 months
Payment: $199/month
The MSRP is the sticker price, but most lease specials provide low payments by not using the sticker price. Instead, the payments are based on the Capitalized Cost (cap cost), which works as the sale price. (The cap cost is negotiable in any lease deal, not just during a special offer.)
The lease-end purchase option (or something similar) is referred to as “the residual” by dealers. The residual is how much the vehicle is anticipated to be worth at the end of the lease, which is what you could buy it for at that time.
The residual is subtracted from the cap cost to determine how much the Camry will depreciate over the lease term, which is 36 months. However, if you do the math, you will notice this difference is not equal to the total payments, which includes interest on the lease. In this scenario, the lease company and the dealer will have about $1,200 of interest to divvy up.
But, “interest” is a word never mentioned during leasing. Instead, a much more convoluted term, money factor, is used. The money factor works just like an interest rate, but it is written as a four-digit number, like .0031. This greatly benefits dealers, since it is tough for buyers to tell if .0031 is a good money factor or not. However, to convert a money factor to an interest rate, multiply it by 2400, which comes out to 7.44%, as shown below:
.0031 x 2400=7.44%
A formula based on the difference between the cap cost and residual, factoring in the money factor and term, is used to determine the total payments, as well as the monthly payment, which is $199 per month, before taxes.
Additional specifications are included to let you know $2499 will be required to take the Camry home, $1,750 of which is a down payment, $550 is the acquisition fee, and the first month’s payment is included. Also, if the vehicle is returned with more than 36,000 miles at the end of the lease, there will be a penalty of 15 cents per extra mile.
However, the fine print also reveals two other important pieces of information possibly affecting your leasing experience. It mentions this lease special is “based on down payment and dealer participation, which may vary by dealer. Payment may vary depending on final transaction price,” as well as the special being available “to qualified Tier 1+ customers through Toyota Financial Services.”
In short, dealers do not have to give you the price specified in the lease and they do not guarantee the money factor used to get the $199/mo payment. Dealers who are less than ethical can use this to deceive customers into spending more than necessary. Once again, this is not a problem exclusive to leasing, but something to be aware of.
How do I know if I should lease?
The true litmus test is to compare the monthly payment for buying and leasing a vehicle, based on your lifestyle. You should also consider how long you plan to keep the vehicle and also to compare a likely trade allowance to what you would still owe.
In the case of the Camry, the lease payment of $199/mo is much cheaper than the monthly payment to buy. At 6% interest over 60 months, using the cap cost as the amount financed, buying the Camry would equate to a $353.53/mo payment.
Although much more money is expended by buying, in the end, you may be able to trade the Camry and get that money back — but you have to get the money from a dealer as trade allowance. If you could accomplish this, you would be likely to have spent about the same amount as if you leased, provided the model retains its high resale value.
However, if the market shifts to biodiesel, a tax break for hybrids is issued, or any other number of events occurs, the Camry’s resale could plummet, causing you to lose thousands in equity.
Not to mention, a Camry is an excellent vehicle to lease or buy, because of its reputation and resale value. With less upstanding models, especially gas guzzlers, the potential to avoid risk by leasing increases greatly.
On the other hand, if you do lease the Camry, you could keep an extra $150/mo over the life of the lease, which is like giving yourself a raise. You could spend it on yourself or put it somewhere it could earn money, such as a money market account, mutual funds or your home loan.
Even without interest, putting away $150/mo. adds up to $5400 by the end of the lease.
Regardless of these factors or anything else, many people will always be against leasing. However, ignoring leasing could cause you to lose thousands of dollars on a Ford when you could be driving a Mercedes or saving hundreds of dollars a month.