Car Leasing 101: Short Version of the Car Leasing Guide
Car Leasing
Car leasing is extremely popular because it provides an attractive method of driving an automobile that might not otherwise be affordable. It offers lower monthly payments than with conventional car loans. About one out of every four vehicles driven by automotive consumers in the United States today are leased.
But leasing is not for everyone. You should take the time to learn about leasing, how it works, and be sure it’s right for you before making a decision.
What is Leasing
Where an automobile purchase loan is a method of financing the ownership of a vehicle, leasing is financing the use of a vehicle for a specified number of months — but it is not renting as many people mistakenly believe.
A lease is a formal contract with a leasing provider (lessor) that allows you (lessee) to drive the provider’s car and only pay for the portion of the vehicle’s value (depreciated value) that you use up during the time you’re driving it. You agree to pay for insurance, licenses, taxes, repairs, and maintenance.
The leasing provider (lessor) retains ownership and title to the vehicle throughout the lease. At lease-end you can simply return your vehicle to the provider, or you may purchase the vehicle and continue driving it.
Benefits of Leasing
Leasing offers the following benefits when compared to purchase loans:
– Lower monthly payments — 30%-60% lower
– More car, more often
– Minimum or no down payment
– Smaller sales tax bite in most states
– No used-car headaches at lease-end
– Have option of returning car or buying it at lease-end
Of course, there are also potential drawbacks such as possible wear-and-tear charges, excess mileage charges, or early termination penalties.
Who Provides Leases
Contrary to popular belief, car dealers do not lease cars. They only help set up and initiate leases between their associated lease finance companies and customers. Financial companies are typically those owned by major car manufacturers, such as Ford Credit or Honda Financial Services. Dealers simply act as agents of their lease finance company to arrange the lease on customers’ behalf.
Once you’ve decided on the car you want to lease, the dealer sells it to the lease finance company, who leases it you. This takes place behind the scenes and your first contact with the leasing company will be when you get your first monthly statement. From that point on, you deal with the lease company with matters regarding your lease. You work with your dealer only for matters regarding the car itself (maintenance, service, warranty, etc.).
Who Should Lease
Leasing makes sense for many people, but not for others. Here’s how to determine if you are a good leasing candidate:
• Are you willing to trade ownership of your vehicle for lower monthly payments? Leasing is a great way to lower your payments or drive a better car for your money, but you must be comfortable with having no ownership of your vehicle, unless you purchase at lease-end.
• Can you stick with your lease until the end? Leases require you to commit to driving your vehicle for a specific number of months — typically 24, 36, 39, 42, or 48 months. If you feel your lifestyle, your finances, or simply your taste in cars may change significantly in future months, you may not be a good lease candidate. To end a lease early is usually troublesome and costly.
• Do you drive more than 12,000 miles annually? If your answer is yes, you may not be a good candidate because lease contracts are typically written with an annual mileage limit, typically 10,000-12,000 miles. If you drive more that the specified number of miles you will pay a fee for every mile over the limit.
• Do you typically keep your vehicles in good condition and change vehicles every few years? If so, you may be right for leasing. Lease providers require you to keep their vehicle maintained and repaired, with no more than normal wear and tear. If you don’t, you’ll be charged at the end of your lease.
• How is your credit rating? If you have a history of paying your bills on time and don’t have excessive debt, you are a good lease candidate. Otherwise, you may be required to make a large down payment and pay higher finance charges or, worse, be refused the opportunity to lease.
People who are good leasing candidates are those who not only want low monthly car payments, but who also have a good credit rating, predictably drive no more than about 12,000 miles a year, keep their vehicles in good shape, and are capable of sticking with their leases until the end.
Shopping for a Lease
The most important element of a good lease deal is the price of the vehicle. Regardless of whether you buy or lease, you should always get the best possible price first. When leasing, this price becomes the capitalized cost, or “cap cost.” Prior loan balances and fees may be added. Rebates, discounts, down payments, and trade-in credit are subtracted. The lower the capitalized cost, the lower your monthly payment. This is the only element of a lease deal that a dealer directly controls — and the only element you can negotiate.
The remaining elements of a lease — money factor, residual value, and related fees — are controlled by the lease finance company — and cannot be negotiated.
Since a lease is simply another form of car financing, finance charges apply. These charges are known as money factor. Money factor is expressed as a very small number such as .00175, which is equivalent to 4.2% annual interest rate. A low money factor results in lower monthly lease payments.
Residual value is an estimate of a vehicle’s wholesale value at the end of a lease term. The longer the lease, the smaller the residual value. Your lease payment is primarily determined by the difference between cap cost and residual value, which is the amount that the value of the vehicle depreciates during the lease. Finance charges and sales tax will also be included in your monthly payment.
When you get lease offers from a dealer, you should use a lease calculator to verify the accuracy of the dealer’s figures.
Leasing Fees and Taxes
There may be certain fees associated with your lease. The fees that lease providers charge may vary both in kind and amount. One of the most common is an acquisition fee, which is an administrative charge for initiating a lease. Another common fee is a disposition fee, usually charged at the end of your lease when you return your vehicle.
At the beginning of your lease, you will be asked to pay your first month’s payment, possibly a security deposit, a down payment, if any, and applicable official fees associated with licensing a vehicle in your state. You will also be asked to show proof of insurance.
In most states, you will pay sales tax only on each monthly lease payment, not on the entire cost of the vehicle.
For a complete guide to car leasing, go to our comprehensive Leasing Guide.