The simplest way to understand leasing is to think of it as an extended car rental in which a consumer pays to use a vehicle for a specific period of time, usually two or three years.
Payments are based on the difference between a vehicle’s transaction price (called the “capitalized cost” in leasing lingo) and what the car is estimated to be worth at the end of the term (its “residual value”). That amount is then financed at the going rate of interest, which may also be called a “lease rate,” “lease charge” or “money factor.” The upfront costs of leasing a vehicle typically consist of the first month’s installment and a “capitalized cost reduction,” which is a fancy term for a down payment.
Automakers will sometimes sweeten lease deals on certain models via cash incentives to keep costs low, although the current market challenges have compromised both car values and availability in recent months. Also, keep in mind that most lease terms are negotiable. While a dealer may not budge on the asking price in this seller’s market, a lessee can usually work out a lower monthly payment by putting more cash down.
Leasing 101: How To Shop Without Buying
To Lease Or Not To Lease
While leasing a car or a truck has traditionally been favored by businesses for its tax advantages, consumers in recent years
have been using it to obtain “more car” for the money without having to finance a new model for an extended loan period.
While the average monthly payment on a new vehicle purchase is now estimated at around $700, and with down payments just over $6,000, lease terms are typically lower. For example, a subcompact Hyundai Kona SUV was recently offered for $179 per month for 36 months with $3,899 down, while a midsize all-wheel-drive Subaru Legacy sedan could be had for $215 per month with $2,899 up front. Looking for something more upscale? An “entry level” Mercedes-Benz A 220 sedan leased for $429 a month with $3,643 down.
Another key advantage to the leasing process is that when the contract expires, a lessee can simply return the vehicle to the dealer without having to worry about trading it in or selling it to a private party. And perhaps most appealing for many consumers right now, the lessee can also purchase the vehicle at the predetermined “buyout price” specified in the contract, and even sell it to a dealer and pocket a profit if, as has recently been the case, it winds up being worth more than the stated residual value.
Let The
Lessee Beware
Leasing a new car, however, also comes with some real disadvantages. For starters, since leasing is basically an extended rental, the process virtually guarantees making car payments for the entire term of your contract.
Likewise, there’s no equity at the end of the term that can be leveraged for a down payment on a subsequent model (the exception being the aforementioned situation where a vehicle is worth more than its residual value). So those wanting to lease or buy another car or truck will have to pay the upfront costs all over again.
New-car leases come with strict mileage limitations, which on some deals can be as low as 10,000 miles per year. Those who exceed the total allotment will face a penalty of 15 to 25 cents per mile when the vehicle is turned in, which can add up quickly, like data overages on a phone. Fortunately, those with longer commutes can negotiate a more generous threshold up front, albeit at a higher cost.
And those who tend to be rough on their cars might want to think twice about leasing. That’s because leased vehicles must be returned in pristine condition, without dents, deep scratches, window cracks or torn/stained upholstery, and with all accessories in good working order. Otherwise the lessee will face costly “excessive wear and tear” fees.
Perhaps the most onerous aspect of the process is that car leases are binding for the entire length of the agreement, and they’re difficult and/or expensive to terminate. Those needing to get out of the contract early will be required to pay a hefty fee and all of the remaining payments. One solution to get around this dilemma would be to lease another vehicle and have the first contract “bought out” as part of the deal. Another is to use an online leasing marketplace through which consumers can transfer their leases (for a fee) to other parties seeking short-term vehicles.
The Bottom Line
In addition to the above advantages, leasing can give consumers time to “sit out” the current market instability while still driving a new vehicle. It’s also a good way to hedge against what are sure to be falling resale values down the road, given today’s inflated new-vehicle transaction prices.
If you’re considering leasing, be sure to check under the “special deals” or “local offers” tabs on automakers’ websites, entering your ZIP code to find any promotional lease deals that are on offer locally. They often vary by region to account for local supply and demand issues. It also helps to check local dealers’ inventories via automakers’ sites to see what’s currently in stock.
Finally, keep in mind that the lowest advertised lease deals are typically available only to so-called “well-qualified lessees” with top credit ratings. This can mean having a FICO score of 781 or higher, which is considered to be “super prime.” Those with lower FICO scores, but who still have sufficient income to qualify, could be charged a higher interest rate, be subject to a larger down payment and/or be required to post a refundable security deposit, all of which would translate into higher monthly payments. So always go into a lease with your eyes open and look out for potential bumps in the road.