Leasing a car comes with many questions and concerns, and those new to the practice may find themselves just not wanting to deal with it. Many people don’t understand the auto leasing process or how it benefits many drivers, and will quickly dismiss the idea as a waste of money.
The truth is, the financial benefits of leasing a car can be enormous for many people. Equipped with the information to lease the right vehicle with the right options, and going to the dealer prepared can make a significant impact on your monthly expenses.
If you are interested in leasing your next vehicle but aren’t sure where to start, we’ve prepared this guide to walk you through everything you need to know about leasing a new car and help you get the best deal on your next lease.
Leasing vs. Buying
Before leasing a vehicle, it’s important to understand how leasing works, how payments are calculated, and ultimately whether it makes sense for you over buying.
Leasing is just a method of financing a vehicle. Many people incorrectly assume that leasing is equivalent to renting and that all the money you put into a lease will never be recovered.
This couldn’t be further from the truth. When leasing a car rather than buying, you are just paying for the portion of the car that you will use over a certain number of years and miles, rather than the entire value.
Let’s run some numbers to show how this process compares to purchasing a new car.
Purchasing a Car
Purchasing a car is a straightforward process compared to leasing. For simplicity’s sake, we will be ignoring sales taxes and dealership fees, and rounding amounts down to the nearest dollar.
Vincent has decided to purchase a car for $22,000 and has a trade-in valued at $4,500. He chooses to make no down payment and wants to finance the vehicle for 24 months.
The financing company offers Vincent an Annual Percentage Rate (APR) of 3%.
First, the trade in value is subtracted from the purchase price to get the principal amount.
22,000 – 4,500 = $17,500
Then, the principal amount is divided by the number of months in the loan.
17,500/24 = $729
Then the monthly interest is added. At 3% APR the amount of interest amounts to roughly $21 each month.
Now the monthly interest is added to the monthly payment.
729 + 21 = $750
When we multiply the monthly payment by the number of months in the loan we get a total of $18,000 paid for the car.
Leasing a Car
At the same time, Jules has decided to lease the car at the same purchase price, with the same value trade-in.
First, there is the net capitalized cost. Just like the principal amount in the previous example, this is calculated by subtracting the trade in value from the purchase price.
22,000 – 4,500 = $17,500
Then, we calculate what is called the residual value. The residual value is the expected value of the vehicle after the term of the lease is over, and is calculated by multiplying the sticker price of the car by the residual percentage.
The residual percentage is the estimated percentage of the vehicle’s value retained after the lease term, and is calculated using many factors such as mileage and market trends, and will be provided by the dealer. In this example, we are going to say that the car will depreciate to 60% of its purchase price over the term.
22,000 x .60 = $13,200
Now we calculate the depreciation fee by subtracting the residual value from the net capitalized cost and divide it by the number of payments. Put simply; the depreciation fee is the monthly payment before we add financing fees, sales tax, and additional fees.
17,500 – 13,200 / 24 = $179
Then the money factor is added, which is the financing fee for a car lease. We are going to use the same APR from the previous scenario of 3%.
We will find the monthly money factor by dividing the APR by 2400.
3/2400 = 0.00125
We can add the net capitalized cost to the residual value and multiply it by the money factor and get the total financing fees for each month of the lease term.
(17,500 + 13,200) x 0.00125 =$38
Finally, adding the depreciation fee to the money factor gives us our final monthly payment before adding fees and taxes.
179 + 38 = $217
Now we can look at where Vincent and Jules are after two years.
Jules has paid a total of $5,208 in transportation expenses.
Vincent has paid $18,000 in transportation expenses. However, Vincent now owns the vehicle. If we assume the residual value was accurate, Vincent’s car is now worth $13,200, making his expenses just $4,800 after the sale.
You might be thinking “But wait! Vincent spent less money than Jules by purchasing his car!”
While this is true, Jules’ situation has its advantages.