Pros and Cons of Leasing a Car - It is a Good Choice for You?
Written by: Kristy Welsh
Last Updated: August 1, 2017
If you are in the market for a new car, you are probably wondering if you should purchase a vehicle or lease it. According to Kelly Blue Book, the average price of a new car or truck sold in the United States in 2016 was $35,421 — up from 2015. Higher prices for cars means higher monthly payments for consumers. This is why car manufacturers and dealerships are always looking for ways to make these cars obtainable for the average American. Hence, the concept of leasing a vehicle, which allows people to get more car for their monthly car payment.
What Does it Mean to Lease a Car?
An auto 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, thereby 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 (residual value) or turn the car back in to the dealership and lease another brand new vehicle. The big question is ~ is leasing a vehicle right for you? This article will lay out the pros and cons of leasing so you can determine if leasing a brand new car fits your budget and your lifestyle.
Pros of Leasing a Vehicle
Leasing a brand new car is a good option for people who:
- Have good credit.
- Buy a car every two to three years.
- Don't put a lot of miles on their vehicles every year.
- Like having a car payment no matter what.
- Keep their cars in immaculate condition.
- Are writing off the car payments through a business expense.
Cons of Leasing a Vehicle
Low monthly payments may tempt one into leasing a car, but leasing is not a good option for people who:
- Drive more than 12,000 miles per year.
- Are not prepared to put the car back to good condition prior to turning it in. (replacing tires, cleaning interior, fixing any dents or dings)
- Have less than good to excellent credit.
- Don't like the hassle of getting a new vehicle every two to three years.
Tips When Shopping For an Automobile Lease
Beware of Dealer Tactics - 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.
Know the Cap Cost - 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.
Make Sure to Do Some Comparison Pricing - 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.
Watch Out For Inflated Interest Rates - 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.
Is There a Down Payment on an Auto Lease?
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:
$350 x 24 = $8,400
How Your Monthly 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.
Other Things to Be Wary of with Leases
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 up to 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, or wore out tires.
Should You Purchase Your Vehicle at the End of the Lease?
After two or three years, you are coming up to the end of your auto lease agreement — now what? Suppose the residual value of the vehicle is several thousand dollars below the retail value, as given in the Kelly Blue Book. After paying lease payments for two or three years, you may feel that you should "get something out of it" by purchasing the car. But is that the right move for you financially?
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.
The Bottom Line
In the end, you must pay attention to every aspect of the deal to make sure you are getting the best price and payment available:
- Always calculate your own lease payments and be ready to challenge the dealer.
- Look over your paperwork carefully.
- Ask to have the money factor (and its corresponding APR) given to you in writing.
Auto Lease Definitions
Below are some terms you will frequently see and hear when you are leasing a vehicle:
- 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.
Hopefully the information in the article has helped you unravel the mystery of auto leasing. Weigh the pros and cons carefully as they pertain to your budget and lifestyle to see if leasing is best for you.