With the exception of those who pay cash for their new car, most of us need to finance part of our purchase. You are probably familiar with how traditional financing works, leasing is simply another option available to us.
Because each of our situations is different, it would be impossible to say that one option is the best for all of us all of the time. The purpose of this section is simply to make you aware of the differences so that you can decide what’s best for you.
First let me say this. If you plan to keep your car forever, then leasing is probably not for you. However, leasing may be a good option for those who regularly trade-in for a new car every two to four years. Leasings lower monthly payments may also work well for those who want or need ‘more car’ than their budget allows. Let me begin by explaining the basics of leasing, and the I will answer some of the more common questions.
How does leasing a car really work?
When you lease a car, your payments are based on the difference between the price of the car (its ‘capitalized cost’) and what it is worth at the end of the lease (its ‘residual value’). If at the end of the lease you wish to buy the ‘rest’ of the car, you can. If not, you’re done.
For example, if you lease a car for three years that has a residual value of 40%, your payments are calculated based on 60% of the value of the car. You also pay interest on the entire amount for the three years. The interest rate is called the ‘money factor.’ If you wish to buy the car after three years, it will cost you the remaining 40%.
Can you negotiate the price of the lease?
You bet. While the residual value and money factor are set by the leasing company, the capitalized cost is essentially how much the car costs. You’ll want to negotiate this figure just as if you were buying the car.
What about mileage?
Good question. You need to evaluate your driving habits to see how many miles you put on your car. Average is about 15,000 miles per year. The more miles you put on, the less attractive leasing becomes since higher mileage lowers the residual value.
However, excess mileage will cost you even if you purchase a car. Think about it. If you rack up a lot of mileage on a car and then sell or trade it, it is going to be worth less as a result. That lost value comes out of your pocket. But if you lease a car, you never own it. Right? Let’s think about this for a minute. Unless you pay cash for a car, do you really own it? If you buy a car and miss a few payments you’ll find out fast who owns it; the bank will repossess the car you ‘own’ faster than you can say “tow truck.”
What happens at the end of the lease?
At the end of the lease you have four options. You may buy the car, sell it privately, trade it in, turn it in and walk away.
1) Buying the car. If you choose to buy the car, you may do so for the residual value or ‘lease end value.’ You are told this amount at the beginning of the lease.
2) Selling the car privately. You may sell the car privately the same way you would if you had purchased it initially. You are simply responsible to the leasing company for the balance still owed (lease end value). You are entitled to any surplus and responsible for any deficit.
3) Trading it in. You may trade-in just as you would if you purchased it initially. The dealer assigns a value to the car and then applies it to the balance owed (lease end value). Any surplus or deficit will affect the new car.
4) Turning it in. You may turn the car in. You may be responsible for any excess mileage or wear and tear charges. Some leasing companies also charge a ‘disposition fee’ of a few hundred dollars.
Leasing may also be worth considering if you are ‘upside-down’ (owe more than your car is worth) with your current car. As I said in the trade-in section, this may not be your best option, but it will usually work especially when you need a new car. Leasing is often more attractive when you are upside-down, since the payments tend to be lower to start with, when you add the negative equity the payments are more reasonable than with a buy. After the lease is up, turn in the car and you’re starting from zero instead of a negative amount. One word of caution: If you attempt to trade out of the lease early you will find that you are really upside-down ,so decide carefully.