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 and getting a quote 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.
We can see that a lease is not throwing your money away, but an alternative form of financing that offers advantages and disadvantages compared to buying. Rather than purchasing the car outright and paying the whole value, you are only paying for the depreciation during the lease term.
Another thing to take away from Vincent and Jules is that the pros and cons of leasing are heavily dependent on lifestyle. Ask yourself the following questions:
The answers to these questions vary for each of us and are important to consider when deciding whether to lease or buy a car.
How to Get the Most Out of Your Auto Lease
Now we know a little more about how to calculate lease payments and how it differs from the car buying process. Next, we can go over how you can influence the terms of your lease to fit your needs.
Whether to put any money down on a lease is one of the most frequent questions we hear about auto leasing. When buying a car, down payments are usually made to lower the purchase price, thus reducing the principal, which decreases the amount of interest paid over the life of the loan.
Additionally, car buyers will make a down payment to prevent going upside down and owing more than the vehicle is worth. In the event of theft or total loss, this lowers the out of pocket expenses of the buyer.
When leasing a vehicle, only the first situation applies. A down payment will be subtracted from the purchase price and as a result, lower the amount of interest paid over the lease term. However, leases are usually short-term, and the amount saved in interest payments is often insignificant. Calculate how much money you will save on interest or ask your dealer to show you what the payments would be when factoring in different down payment amounts.
Ultimately it is up to you to determine whether the amount saved on interest is worth the down payment amount.
When leasing a vehicle, the number of miles you can drive per year is limited by the terms of your agreement, and you will be subject to fees when you exceed that limit. If you’re thinking of driving the car for work such as if you work for a taxi service, it’s probably not the best idea if you want to stick to your miles on the agreement.
Mileage limits are one way you can affect how much value you get out of your lease. The more mileage the dealer expects you to put on the vehicle will contribute to its residual percentage.
It’s no secret that vehicles with more mileage on them are less valuable. Choosing mileage limits that are appropriate for your lifestyle will ensure that you don’t spend too much on your monthly payments or end up with additional fees after the lease ends. Closed-end lease agreements have mileage limits. The number of miles you can drive per year is limited by the terms of your agreement, and you will be subject to fees when you exceed that limit.
Long and Short-Term Leases
Dealers will usually offer leases in various lengths.
A short-term lease is usually 24 months or less, with a long-term lease being anything longer than 24 months. Most dealers have a minimum of 24-month lease terms, but shorter terms may be available through lease swapping. Short-term leases have some advantages over long-term leases.
A short-term lease can allow you take advantage of the manufacturer’s warranty throughout the entire lease term.
Making no down payment is less costly. In general, the longer a term of financing, the more you will pay in interest. Short term leases make the amount of interest significantly lower.
Long-term leases will usually result in a lower monthly payment, but are a longer commitment and will cost more overall due to financing fees.
Although you don’t own a leased car, you are still required to carry insurance for it. Coverage that is mandatory varies by state and the agreement you sign with the leaseholder.
Some leaseholders may require you to purchase additional coverage other than that which is required by state law. Before signing a lease, go over the agreement and calculate what additional insurance costs you might incur and factor it into your decision.
In most cases, lessees will have the option to turn in their vehicle at the end of the lease or buy the car from the dealer. This gives leases another element of flexibility which can benefit many drivers.
Usually purchasing your vehicle is just a matter of paying the residual value to the leaseholder. Remember that residual value is not the same as market value. In some cases, the market value may be higher, making purchasing the car a great deal.
Additionally, an option to purchase the car at the end of the lease can help the Lessee avoid certain fees associated with returning the car, especially those connected to the condition or excess mileage on the vehicle.
Keep in mind; purchase options do come with a fee of their own in most cases. This fee is to prevent dealers from taking significant losses by selling vehicles for less than they are worth. When deciding whether to turn in a vehicle or take advantage of a purchase option; consider all applicable fees before making a final decision.