Leases

When the price of the average car increased to $15,000 - $20,000 in the 1990s, auto dealerships had to come up with a way for average people to afford their products. They came up with the leasing idea, which allows people to get more car for their monthly car payment. A lease is essentially a long-term rental of a brand-new car. A customer signs a contract to rent the car for a period of two to three years, making monthly rental payments. The customer agrees to keep the car in good shape and drive it only a certain number of miles a year. At the end of the lease term, the customer can purchase the vehicle for a predetermined cash amount. This value is called the residual value.

Leases can be a good option for people who:

• Have good credit
• Buy a car every 2-3 years
• Don't put a lot of mileage on their vehicles
• Are going to have a payment no matter what
• Keep their cars in immaculate condition.
• Are writing off the car payments through a business expense

Most people don't understand how leases work, so it's pretty easy for dealers to rip them off. Like a magician who distracts you with some meaningless hand movement to disguise the way the trick really works, the dealer keeps you focused on the monthly payment.

Even if you think you have negotiated a price, known as the "cap cost," the dealer can inflate the price on your paperwork, and often they succeed. The cap cost is important because it is the price on which the lease payments are based. If you do catch a dishonest dealer in the lie of raising the cap cost, he may tell you that it represents finance costs (baloney), or that your lease payments are not based on this cost (blatant lie). The bottom line: Read your paperwork and take your time about getting questions answered.

Dealers also try to sell you on leases by doing a comparison between the payments for a lease and the payments for the same car on a conventional loan. Invariably, the comparisons show the lease payment to be the winner. Check the payment calculations - are they based on the same number of year's payment calculations? Most lease payments in these comparisons are based on a five-year payment schedule. Conventional loan payments are often calculated on a three-year schedule, so the dealer is giving you a comparison of apples and oranges.

Since you are just "renting" the car, and technically are not getting a loan, the leasing company isn't required by law to tell you the interest rate on which they are calculating the lease payments. In fact, the "interest rate" a lessor is charging you is not an interest rate at all (since again, you are not getting a loan) and is called the "money factor." The money factor is a fractional number, such as 0.0042, to calculate the lease fee or charge. The monthly payment combines the resulting fee with the depreciation charge. Neither the money factor nor the lease charge is an interest rate in the traditional sense; both are part of a formula devised by lessors to determine their profit. Yep, profit. The reason lease companies are in business.

Will dealers tell you the money factor? Yes, but only if you ask. The formula for converting the money factor to an APR is also not required to be given to the consumer by law. Like credit score calculations, it is somewhat of a mystery.

If the money factor is expressed as a percentage, convert the percentage to the money factor by dividing the number by 24 (yes, it's 24 regardless of the term of the lease). For example, a 7 percent (.07) interest rate converts to a .0029 money factor.

You are not buying the car, so there is no such thing as a down payment in a lease. What you are doing is making payments in advance. Say you put $2,000 down to make a $400 payment over 24 months drop to $350. Sound like a good deal? Let's look a little closer. This may prove more expensive in the long run.

Let's say, for example, that you have a two-year lease - you will pay $400 x 24 = $9,600. But if you slap down the $2,000 up front, you're actually paying $800 more for the vehicle:

How a Lease Payment is Calculated

To calculate a lease payment, you must know what the car will be worth at the end of the lease - the "residual value." The difference between the cap cost and the residual value is the figure that the lease payments are calculated on.

So if you have a car with a cap cost of $18,940, and a residual value of $7,125, the payment amount is calculated on $11,815. With a money factor of 0.00166 (an APR of 4%), the payments are $329.

If you want more details, Edmunds has a nice auto lease calculation page.

Watch out for these additional factors when considering a lease:

• Some leases involve all kinds of up front fees, many of which are non-refundable.
• Most leases only allow a maximum of 12,000 - 15,000 miles a years, after which you are charged between 10-25 cents a mile.
• In addition, when you turn in your vehicle, it is inspected with a fine tooth comb, and you can expect to pay a high fees for every scratch, nick or dent.

Suppose your residual value is several thousand dollars below the retail value, as given in the Kelly Blue Book (http://www.kbb.com). After paying lease payments for two years, you may feel that you should "get something out of it" by purchasing the car.

You also can trade in your leased car as if you owned the car with another dealership. Some benefits to selling the car out of the lease are that you will get the full security deposit back, you won't pay a lease disposition fee, you don't have to worry about excess wear and tear charges, and you don't have to worry about how much tread is left on the car's tires. But before you start counting your profits, make sure that your lease agreement allows you to trade or sell the car before the end of your lease term.

In the end, you must pay attention to every aspect of the deal: if you don't, your vehicle could end up being repossessed

• Always calculate your own lease payments and be ready to challenge the dealer.
• Look over your paperwork carefully, and don't allow dealers to pressure you into signing until you are ready.
• Ask to have the money factor (and its corresponding APR) given to you in writing.

Here are some auto leasing terms:

Cap Cost: Lease payments are based on the cap, which is the selling price of the car.

Residual Value: This is the predicted value of the vehicle at the end of the lease term, and is expressed as a percentage of the MSRP (the sticker price). Most cars have a residual value of between 50 and 58 percent for a 36-month lease. Sometimes, dealers raise the residual value to lower monthly payments. This is OK, unless you plan to buy the car at the end of the lease.

Money Factor: This is lease-speak for "interest rate." It plays a big part in the calculation of a lease payment. If the money factor is expressed as a percentage, convert the percentage to the money factor by dividing the number by 24 (yes, it's 24 regardless of the term of the lease). For example, a 7 percent (.07) interest rate converts to a .0029 money factor.

Term of the Lease: This is the length, in months, you lease the car for. Popular leases are 24, 36, 48 and 60 months. Some lease companies write leases for 38 or 42 months. The 36-month lease makes the most sense because most cars will be covered by the factory warranty for the entire time.

Want to research state laws for secured transactions? (CLICK HERE)